For property investors, one of the most common questions asked is whether to invest as an individual or as a limited company. Buy-to-let (BTL) investing has changed dramatically in recent years thanks to regulatory, legal and tax changes. Many landlords have reacted to these changes by changing to limited company ownership. In this compact guide we look at how to make sure you’re investing in the most tax efficient way possible.
Tax savings on rental income
If you’re using a company for BTL investment, there are attractive tax benefits. In the UK companies pay corporation tax, which is currently set at 19% and set to fall to 17% in April 2020. This rate is fixed no matter how much profit you make. By comparison, if investing as an individual tax rates of up to 45% are chargeable on income.
Another major benefit for limited companies is that they are exempt from mortgage interest relief restriction, which was introduced in April 2017 for individuals. It’s being phased in over four years and by April 2020 the amount of tax relief available to BTL investors will be dramatically reduced. If you’re investing through a company, you won’t be affected by this change. However, you do need to be aware of new corporate interest rules restricting tax deductions for interest when a company’s interest expense is more than £2m per year.
Taking money out of a company
Money can be taken out of a company as a dividend and from April 2018 for the recipient shareholder the first £2,000 is tax free. Anything over this amount is charged at 7.5% for a basic-rate taxpayer, 32.5% for higher tax rate individuals and 38.1% for people in the additional tax rate bracket. This is on top of the corporation tax that has already been paid by the company. When you combine both tax bills, it pushes the overall rate of tax to just under 50% in some cases, which is higher than the amount of tax paid by an individual owning a BTL property directly.
The money can also be paid out as a salary, but this typically works out as a more expensive way to extract money because National Insurance contributions also need to be paid. If a landlord can afford to leave their rental income (or proceeds from a sale of property) within a company, this avoids paying more tax to take money out of the company. However, if the landlord needs to pay out the company’s profits to fund personal expenses, this reduces the tax benefit. So, where a landlord doesn’t need to take money out of a company, it can be preferable to use a company. Where the landlord does need to extract funds, company ownership can lead to higher overall rates of tax – however even in this case where the landlord has a lot of debt, there can still be tax savings as the company is not subject to BTL interest restrictions. When deciding which tax option is best for you, you need to look at the tax applied when taking money out of a company compared to the impact of the interest restrictions on individual landlords.
What happens when you come to sell?
Corporation tax is paid when a company sells a property. This is currently 19% (falling to 17% in 2020). This is less than the capital gains tax paid by individuals, which is 28% for a taxpayer whose income and gains exceed the basic rate threshold. However, if money is taken out of a company the shareholder must pay income tax and this can mean paying significantly more tax than if the property were owned directly by the individual. Therefore, if a landlord is planning to hold property for the long term, or following sale of a property is happy to reinvest from the company, a company can be a tax efficient way to hold the investment property. But if a landlord wants to extract proceeds from the sale of a property to fund his own expenses, the overall tax bill is likely to be more than had he held the property directly.
Can I use an offshore company?
Previously there were significant benefits for non-UK resident investors in using a non-UK company. However these benefits are being eroded by changes in tax law. A non-UK resident individual or company buying UK property from April 2019 will pay tax on income and gains from the property in much the same way as his UK counterpart. For UK residents, the problem with using a non-UK company is that the company needs to be centrally managed and controlled abroad in order to avoid the UK tax laws. This means board meetings and major decisions about the company need to be made from outside of the UK (which can be impractical for small BTL landlords).
Stamp Duty Land Tax
A company is always subject to the higher rates of SDLT when buying a property however there may be ways to legitimately reduce the amount you need to pay.
How to set up a limited company
If you are setting up a company to buy new properties, this is quite straightforward. However, if you have an existing portfolio of property which you want to transfer to a company, on transfer there can be significant Capital Gains Tax and Stamp Duty Land Tax charges. There are ways to avoid or mitigate these, but they are complex and do not work for every scenario.
Pros and cons
BTL is still a popular investment vehicle, especially when compared to the dismal interest rates on offer from traditional savings accounts. Mortgage rates have also hit new lows, adding to the attractiveness of this investment. That said, it is important to remember that there can be disadvantages to owning property through a company. It can cost tax to take money out of a company; there can be more overall tax when a property is sold; and there can be estate planning tax disadvantages. Compliance costs for a company are likely to be higher. You will need to prepare accounts for the company at the end of the tax year and file these at Company’s House as well as corporation tax returns. So potential investors need to weigh up all the options before making a decision
A longer version of this guide is available from Delph at [LINK].