Much has been said about the merits of running a buy-to-let business through a private limited company. But the decision of whether to buy a property as an individual or through a company depends on numerous factors. This article briefly explains some of the most critical factors. It also suggests which strategy is preferred in some typical scenarios.
Other income Does the owner have any income in addition to rental profit, and how much? For example, from employment or other properties?
Mortgage or cash Does the property have a mortgage against which rental income can be offset, or is the property 100% owned?
Draw income or reinvest profits Will you need to extract the rental profit to support your current lifestyle or do you intend to retain and potentially reinvest the property’s profit to grow your portfolio?
Exit strategy How will you decide to deal with capital gains?
Relevant taxation rules
All the above factors impact your tax position. Remember that individuals and companies are taxed differently.
If you own an investment property through a limited company, you will pay corporation tax at 19% (down to 17% by 2021) on rental profit. If you extract the after-tax profit to yourself in the form of a dividend, you will pay 7.5% income tax for the basic rate, or 32.5% for the higher rate. However, if you keep the profit in the company instead of taking it out as dividend, no further tax is payable. You can then accumulate the profit and reinvest, in order to grow your portfolio.
If you own an investment property as an individual, you will pay income tax on rental profit at 20% for the basic rate, or 40% for the higher rate. You will not have a company in which to keep the profits, therefore all profits will be taxable.
The rules for mortgage interest can also make a difference on taxable profit. If you are a higher rate taxpayer owning an investment property as an individual, only 20% (out of the 40%) of the mortgage interest costs can be deducted from rental profit by 2021. If you own the property through a company, the full amount of mortgage interest costs is deductible. This rule is likely to persuade higher rate payer with a mortgage to own the property via a limited company.
A note to the scenario analysis is that it assumes the profit is taken out of the company in the most tax efficient way.
Scenarios that it is beneficial to own the property as an individual:
- Your total income including rental and non-rental income is below £46,350 (which is the basic rate band). For example, if you are retired and have a £30,000 annual income in combined state pension and occupational pension, and you expect rental profit to be less than £20,000, then own the property under your own name.
The reason is that profit is tax once at 20% once only (as opposed to 19% corporation tax and 7.5% dividend tax), and ,mortgage interest is expensed at 20%, no difference between the two approaches
- If all the three conditions below are met, it is also beneficial to own the property as an individual:
- Non-rental income is above £46,350
- All rental profit is extracted from the company
- Property has no mortgage
Scenarios in which it is better to own the property via a limited company:
- Non-rental income exceeds £46,350, and at least half of the rental profit is kept in the company. As long as these two conditions are met, it is better to own the property via a limited company, with or without mortgage.
- Non-rental income exceeds £46,350and the property has a mortgage. keeping or extracting profit.
How does exit strategy affect the decision?
The way in which you choose to “exit” from your investment (more specifically – how will you treat capital gains) has a significant bearing on the decision.
More options are available to limited companies at exit. Individuals will pay 18% (basic rate tax payer) or 28% (higher rate tax payer) capital gains tax on selling investment properties. Limited companies will pay corporation tax on profit (capital gain). The corporation tax rate is currently 19% and will be reduced to 17% by 2021.
In addition, limited company directors can claim entrepreneurs’ relief when closing a company. The tax rate is 10%. The qualifying condition for the entrepreneurs’ relief does require that the company is a “trading company” – the property investment company is NOT considered to be a trading company in this context. That is one of the reasons it is called a Special Purpose Vehicle (SPV). However, the property investment company can turn to a “trading company”. For example, the company could change the normal residential letting into a furnished holiday letting business. The requirements to be a Furnished Holiday Letting (FHL) are:
- The property is sufficiently furnished
- The total of all lettings that exceed thirty-one continuous days is not more than 155 days during year
- The property must be available for FHL letting for at least 210 days during the year
- The property must be let as FHL commercial for at least 105 days during the year
Companies must operate as an FHL for a minimum of one year to be able to claim entrepreneurs’ relief.
Another option open to you is to create a company pension scheme and make employer contributions to the employee directors. Employee contribution is not mandatory, and the pension contribution is company expenditure, hence it reduces taxable profit.
Something to watch out for
As usual, there is a catch – ATED (Annual Tax on Enveloped Dwelling), which is annual tax on companies that own UK residential properties valued at more than £500,000. The annual charges are £3,650 for properties valued at between £0.5 million and £1 million, and £7,400 for properties valued at between £1 million and £2 million. For this purpose, the properties are re-valued every 5 years. The last valuation date was April 2017, and the next date will be April 2022.
However, a number of exemptions are available. For example, if the properties are used in a business including property rental business, they are exempt from ATED. You can claim the rental business relief and pay no ATED.
Big picture (Other factors, some final considerations?)
There are other considerations when investing in buy to let properties. One typical consideration is that sometimes cash buyers can secure the desired property ahead of buyers with a mortgage. Therefore, the lead time in setting up your company you might cause you to miss out on an investment opportunity with promising future growth because you want to save tax – will you end up gaining or losing? Additionally, it’s essential to evaluate how much rent can I afford making 17 an hour. It is also not uncommon for mortgage interest rates to be higher for limited companies than for individual owners. These and all the preceding factors need to be considered before making your decision.