Landlords looking for a tax-efficient income stream

Investing in bricks and mortar has become less favourable after successive tax rules were introduced. It’s even more important for landlords to consider the tax implications of their property investments.

This tax-planning scenario explains how landlords could use a Venture Capital Trust (VCT) to provide a tax-efficient income stream.

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About this planning scenario

Daniel and Helen need a tax-efficient way to invest additional income

Daniel and Helen have been married for 30 years. Daniel pays higher rate tax and has adequate pension provision.

Helen, on the other hand, invested in property to help fund her retirement. Helen earns £30,000 of rental income (after costs) from her properties and also receives an income from her job which covers her living costs. She expects to pay £6,000 income tax this year.

Both Daniel and Helen want to enjoy a tax-efficient income during their retirement. But Helen, in particular, doesn’t feel ready to sell her properties and be left with a big capital gains tax bill.

Helen’s financial adviser suggests investing in a VCT

Helen talks to her financial advisor, who makes an assessment based on:

• Her risk profile
• Her investment time horizon: more than five years
• Her attitude towards investing in smaller companies

Based on those factors, Helen’s adviser suggests investing £20,000 of her annual rental income in a VCT each year for five years and putting the remaining £10,000 in an individual savings account (ISA).

The upfront income tax relief Helen makes from her VCT investment (£6,000) would eliminate the annual income tax she has to pay on her rental income.
In order to keep upfront income tax relief claimed, VCT shares must be held for at least five years (should Helen sell the shares before then, she’d have to repay the tax relief to HMRC). However, after five years, Helen could sell her first VCT investment, then reinvest any sales proceeds in another VCT and use the additional income tax relief to reduce her year six income tax bill.

Similarly, Helen’s year two VCT investment could be sold and reinvested in another VCT in year seven, giving her additional income tax relief, and so on.

Investing £20,000 to claim £6,000 income tax relief

This flow chart shows how Helen can claim income tax relief from each VCT investment made across several consecutive tax years. We’ve used six years as an example but in practice she could use this method to keep claiming income tax relief indefinitely. This is, of course, subject to certain conditions, including the requirement to hold VCT shares for at least five years in order to retain the 30% upfront tax relief. If an investor needs guaranteed income, cannot tolerate loss or is uncomfortable losing immediate access to their money, then VCTs are not suitable.

Note: Tax rates and allowances are correct for the tax year 6 April 2023 – 5 April 2024. For purposes of this illustrative example, we have assumed no gain or loss on investments, and it does not take into account any initial fees or ongoing charges that will be incurred. VCTs are high risk and inherently different from pensions and ISAs. When clients choose to sell VCT shares, they are often sold at a small discount to the value of their underlying net asset value, so the impact of this should also be considered when assessing any specific products. Please note, after selling shares in a VCT, it is not possible to claim tax relief on new shares bought in the same VCT within six months of the initial sale.

Please note that before investing in a VCT, investors should read the product prospectus and Key Information Documents (KID).

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