Investment in property has been and continues to be a popular form of investment for many people. It is seen as a route by which:
- relatively secure capital gains can be made on eventual sale
- income returns can be generated throughout the period of ownership
- mortgage finance is covered in repayment terms by the security of the eventual sale of the property and in interest terms by the rental income.
Of course, the net returns in capital and income will depend on a host of factors. But on the basis that the investment appears to make commercial sense, what tax factors should you take into account?
Buying as an individual or in a company
Buy to let properties can be purchased in the following ways:
- as an individual
- as joint owner or via a partnership (often with a spouse)
- via a company.
There are significant differences in the tax effects of ownership by individuals or a company.
Deciding the best medium will depend on a number of factors:
Capital gains tax (CGT) on the disposal of an asset is generally calculated by deducting the cost of the asset from the proceeds on disposal and reducing this by the annual exemption, which is currently £11,700 per annum.
Capital gains are treated as an individual’s top slice of income and generally taxed at 18% for low rate tax payers and 28% for high rate tax payers.
The decision as to who should own a residential property to let is a balancing act depending on overall financial objectives.
The answer will be dependent on the following factors:
- Do you already run your business through your own company?
- how many similar properties do you want to purchase in the future?
- do you intend to sell the property and when?
Company versus personal ownership - eventual disposal
If you already run your business through a company it may be more tax efficient to own the property personally as you will be able to make use of your CGT annual exemption (and your spouse’s annual exemption if jointly owned) on eventual disposal to reduce the gain.
In contrast, a company can still use indexation allowance to reduce a capital gain. This effectively uplifts the cost of the property by the increase in the Retail Price Index (RPI) over the period of ownership. For disposals of assets on or after 1 January 2018, indexation allowance will be calculated using the Retail Price Index factor for December 2017 irrespective of the date of disposal of the asset.
Indexation is not available to reduce the gain on the disposal by an individual so in situations where indexation allowance is substantial, this could result in lower gains.
Company versus personal ownership - rental income
For personally-owned property the net rental income will be taxed at your marginal rate of tax, but if you are financing the purchase with a high percentage of bank finance, the income tax bill will be relatively small.
However for rented property with personal ownership the deduction for finance costs is restricted to basic rate relief from April 2017. This restriction is to be phased in over a four year period and will impact higher and additional rate taxpayers.
The net rental income will be taxed at the current corporation tax rate of 19%, which is generally lower than for an individual. Where the purchase is being financed with a high percentage of loan/bank finance, the corporation tax bill will be relatively small.
But there are other factors to consider:
- there is frequently a further tax charge should you wish to extract any of the proceeds from the company
- inserting the property into an existing company may result in your shareholding in that company not qualifying for entrepreneur's relief. You could however form another company to protect the trading status of the existing company.
If you do not have a company at present
Personal or joint ownership may be the more appropriate route but there are currently other significant advantages of corporate status particularly if you expect that:
- you will be increasing your investment in residential property
- you are unlikely to be selling the properties on a piecemeal basis; or
- you are mainly financing the initial purchases of the property from your own capital.
If so, the use of a company as a tax shelter for the net rental income can be attractive.
Use of a company as a tax shelter
Profits will be taxed at the current corporation tax rate of 19%. This rate applies to trading companies or property investment companies. Where profits are retained, the income may be suffering around half of the equivalent income tax bills. That means there are more funds available to buy more properties in the future.
Tax efficient long-term plans
There are two potential long-term advantages of the corporate route for residential property:
- is there an intention to sell the properties at all? Maybe the intention is to retain them into retirement (see below, ‘using the company as a retirement fund’)
- can the shares be sold rather than the property? (See below for issues regarding selling the shares.)
Using the company as a retirement fund
A potentially attractive route is to consider the property investment company as a ‘retirement fund’. If the properties are retained into retirement, it is likely that any initial financing of the purchases of the property has been paid off and there will be a strong income stream. The profits of the company (after paying corporation tax) can be paid out to you and/or your spouse as shareholders.
Changes to the taxation of dividends mean that:
- the cash dividend is the gross amount potentially subject to tax (no tax credits are available)
- a Dividend Allowance charges the first £2,000 of dividends received in a tax year at 0%
- for dividends above £2,000, dividend income will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
Selling the shares
CGT will be due on the gain on the eventual sale of the shares.
The share route may also be more attractive to the purchaser of the properties rather than buying the properties directly, as they will only have 0.5% stamp duty to pay rather than the potentially higher sums of Stamp Duty Land Tax (SDLT) on the property purchases.
Stamp duty land tax (SDLT) and devolved property taxes
SDLT is payable by the purchaser of the property.
Corporate investment in expensive residential property
Where expensive residential property, valued at more than £500,000, is purchased by a 'non natural person', broadly a company, there is a potential charge - the Annual Tax on Enveloped Dwellings (ATED). The ATED is payable by those purchasing and holding their homes through corporate envelopes, such as companies. In addition a higher rate of SDLT of 15% applies to the purchase.
There are exemptions from the higher rate of SDLT and the ATED charge; in particular, property companies letting out residential properties to third parties.
CGT is charged at 28% on disposals of properties liable to ATED and valued at more than £500,000.
This factsheet has concentrated on potentially long-term tax factors to bear in mind.
You need to decide which is the best route to fit in with your objectives. We can help you to plan an appropriate course of action so please do contact us.
Telephone: 03333 219 000