Iain Rankin looks at why more and more landlords are operating via a limited company.
The introduction of ‘Section 24’ - the restriction of interest and finance costs as a tax-deductible expense - has seen a huge change in the way that many landlords operate their rental activities.
Prior to those changes, operating your rental business through a company was rare, and was utilised by landlords with much larger portfolios. There was simply no need for most landlords to incorporate their rental businesses. Also prior to the changes, mortgages available for property companies - often called SPVs (special purpose vehicles) - were scarce and not very competitive.
Landlords and incorporation
The strategy of incorporation is not for every landlord. It is more useful for higher and additional rate taxpayers and those who were previously basic-rate taxpayers who have become higher-rate due to these changes. Getting the ownership structure right can, however, in the right circumstances, make a huge difference to the amount of tax paid over a taxpayer’s lifetime from rental income.
What then are the potential advantages and disadvantages of holding property in a limited company?
Advantages of using a company to invest in property
1. Lower tax rates
The main reason why landlords use a company to invest in property is to take advantage of corporation tax rates and dividend tax rates, which are lower than income tax. If you are a higher rate taxpayer, you pay 40% on your rental profits; additional rate taxpayers even more. For a limited company, however, the corporation tax rate is currently 19%.
If you own and rent a property held outside a limited company, you are taxed on all your rental profit, no matter how you withdraw it. On the other hand, a limited company can choose to distribute its profit in the form of dividends to shareholders. As a company director, you determine the income you receive in a particular year; some years you may take a sizeable dividend when other income is low. Other years, when the opposite is true, you may not. Although dividends are still taxable, there is currently a £2,000 tax-free allowance per individual. Or you can simply leave the profits, essentially reinvesting them within the company to buy the next property.
2. Tax treatment of mortgage interest
From 6 April 2020, mortgage interest will no longer be an allowable expense for individual property investors. Instead, they will claim a basic rate allowance. For higher rate taxpayers, effectively 50% of the interest amount will no longer be deductible against tax. This change began to be phased in gradually over four years from April 2017.
Landlords with rental property within a limited company are unaffected by these changes. Instead, limited company landlords can subtract mortgage interest costs in full from their rental income before calculating their corporation tax. This means limited company borrowers will have a significantly reduced tax bill.
3. Transferring ownership to avoid inheritance tax
Outside of a company structure, if you wish to gift a property to your child, this will incur a capital gains tax (CGT) liability. However, if you hold the property inside a company, gifts of shares to family members will be potentially exempt transfers (assuming they are bona fide) and, therefore, could reduce your taxable estate for inheritance tax (IHT) purposes. If it is done correctly, the ownership can pass to your children tax-free, as the value of the transfer can be held over for CGT purposes.
A property investment company can also be used as a means of providing an income to other family members, in addition to providing an IHT planning structure. Family members can be encouraged to take an active part in the running of the company and control can gradually be passed down.
4. Limited liability
The word 'limited' refers to the 'limited liability' of the company’s shareholders. If the company goes bust, the worst that can happen is that the company ceases trading as it is insolvent.
However, for an individual or a partner in a partnership, you could be forced to sell your own possessions – including your home - to meet any outstanding debt.
Disadvantages of using a company to invest in property
1. Mortgage availability
Rates and fees are likely to be higher than for a personal buy-to-let mortgage since the number of mortgage products on offer for limited companies is still much lower than for individuals. However, this situation is changing as ever more property investors hold properties in a company structure.
You will still need to give a personal guarantee and your own finances will be scrutinised, so think of the company more as a 'tax wrapper'.
2. Personal tax issues
If you intend leaving your rental profits within the company to re-invest, there is no issue. The company pays corporation tax on your rental profits, and the post-tax income is left to roll up to buy more properties, or maybe invest in a pension.
However, there may be an occasion where you need to take out a large one-off sum from the company. Removing large amounts of profits from a company as a dividend can incur personal tax charges of up to 38.1%.
3. Additional costs of compliance
Companies have additional running costs, as they require accounts to be filed with both Companies House and HMRC, and directors must approve annual confirmation statements. This creates an added layer of responsibility for landlords choosing the limited company route.
This can be handled by your accountant, but it will naturally come at some additional cost.
4. Loss of some tax reliefs
If you ever need to sell a property held in a limited company, you should be aware that companies do not pay CGT on the profit like an individual would. As such, there is no annual exempt tax-free amount (currently £12,000). Instead, companies pay corporation tax on the profit. Of course, for higher rate taxpayers, this compares favourably to the 28% CGT rate after the annual exemption.
If you are ever planning to occupy a rental property as a main residence, using a company structure would not be beneficial. The company would not be able to claim PPR (principal private residence) relief on a future disposal. It is worth pointing out that there can also be quite negative tax consequences if a director lives in a property owned by their own limited company.
Is a limited company right for you?
Every landlord has differing circumstances. The decision as to whether a company should be used to hold new investment property will essentially depend on your future intentions. Ask yourself the following key questions:
• Do I have a lower-earning spouse in whose name the property income could be put?
If not, for higher rate taxpayers, the lure of paying the much lower rate of corporation tax is very strong.
• Do I need property profits to cover my living costs?
If not, leaving profits rolling up in the company - for future purchases, or just until your non-property income falls - will leave you better off than if you need to take it out to spend.
• Do I need mortgages to grow my property portfolio?
The ability to claim the entire cost of your mortgage interest as a deduction against corporation tax is a major argument in favour of using a company for higher-rate taxpayers.
Ultimately who am I buying property for?
In the early days, this will be you, but you should consider your exit strategy – do you plan to sell off your property portfolio to pay for your retirement, or is it important that you pass on your portfolio to your children or grandchildren?
If passing on your properties is important to you, holding them within a limited company (if structured correctly) could result in large IHT savings.
Practical tip
Every landlord’s circumstances differ. By building a portfolio via a limited company, it is possible to make substantial tax savings; but it may not work for every landlord. Weigh up the ‘pros’ and ‘cons’ and check first that there isn’t a simpler option that suits your circumstances better.
