I own one buy-to-let property that I purchased back in 2012. Contrary to what most landlords seem to be doing this year, I am hoping to buy a second one as I see property as a safe bet in the long run and a good hedge against inflation.
But I can’t work out whether to buy in my own name or set up a limited company to do so.
I appreciate that the mortgage costs are a little higher, but holding property in a limited company means I can offset the mortgage interest for tax purposes.
My number one concern is that it seems I might become double taxed when holding in a company.
Going corporate: Our reader is trying to decide whether to set up a limited company to fund his next buy-to-let purchase
As I understand it, I’ll pay corporation tax on any profit I make and then pay income or dividend tax on any income I then pay myself. Is this right, and can I avoid this?
Alternatively, I could keep the property in my own name and pay any rental profit into my pension.
I own my own home with a mortgage, and am a higher-rate taxpayer earning around £60,000 a year. I also make an additional £11,000 of gross rental income each year from my other buy-to-let. I have a partner (also a higher-rate taxpayer) and two children.
The principal aim with these buy-to-lets is to help fund my retirement, but it would also be nice to be able to pass the properties to my children without a massive inheritance tax bill.
My current investment property is in my own name, so I’d also like to ask if there is any benefit of switching that over to the limited company model as well.
Ed Magnus of This is Money replies: You will not be alone with this conundrum. Buy-to-let investors are increasingly purchasing property via limited companies, rather than in their own personal names.
Owning within a limited company comes with various tax advantages, including the fact that corporation tax is lower than income tax.
This allows landlords to build up profit within the company, which means they can use it to re-invest towards another property sooner than they might otherwise have done if owning in their own name.
What is the corporation tax rate?
If your company made more than £250,000 profit, you’ll pay the main rate of Corporation Tax, which is 25 per cent.
If your company made a profit of £50,000 or less, you’ll pay the ‘small profits rate’, which is 19 per cent.
You may be entitled to ‘marginal relief’ if your profits were between £50,000 and £250,000.
The £50,000 and £250,000 profit thresholds are proportionately reduced for short accounting periods and by the total number of ‘associated companies’ your company has.
Owning in a limited company also allows property investors to fully offset all of their mortgage interest against their rental income, before paying tax.
This differs from landlords who own property in their own name. They only receive tax relief based on 20 per cent of their mortgage interest payments.
This is clearly less generous for higher rate taxpayers, who previously received a 40 per cent tax relief on mortgage costs before a 2016 rule change.
A higher rate taxpaying landlord with mortgage interest payments of £500 a month on a property rented out for £1,000 a month now pays tax on the full £1,000, with a 20 per cent rate on the £500 that is being used towards the mortgage.
A landlord who owns in a limited company with mortgage interest payments of £500 a month on a property rented out for £1,000 a month would only pay tax on £500 of that income.
Put simply, it means that whilst individual landlords are effectively taxed on turnover, company landlords are taxed purely on profit.
However, landlords who have property under their own name can still fully offset costs such as letting agent fees, repairs and service charges.
Landlords with expensive mortgages could benefit from company structure
For many investors, the mortgage interest is likely to be the main cost. The average two year fix is now 6.48 per cent, according to Moneyfacts, up from 2.91 per cent two years ago.
On a £200,000 interest -only mortgage – which is commonly used by landlords – that’s the difference between paying £1,081 and £485 each month.
As interest rates have risen, the advantages of owning buy-to-lets in a limited company have increased.
The rise of corporate ownership: So far this year 74% of new buy-to-let purchases in England and Wales went into a company structure, up from 68% last year and just 41% in 2015
However, whether there is an advantage to be had or not depends on the landlord’s individual circumstances.
For example, lower-rate taxpayers, particularly if they don’t have a big mortgage on their buy-to-let, may be better off holding their buy-to-let in their personal name.
There are also the added mortgage costs to take into account when buying via a limited company, as lenders usually charge higher rates.
Finally there is an added layer of bureaucracy that comes with a company structure. Company accounts must be formally prepared and filed, records maintained, and directors appointed.
This creates more work for landlords choosing the limited company route, and an added cost if they use an accountant.
We decided to speak to Manjinder Bains, a chartered tax advisor at UK Landlord Tax, Natalie Field, an accountant at TaxScouts and Chris Sykes, technical director at mortgage broker, Private Finance for their advice on the matter.
What would you advise?
Natalie Field replies: As a higher rate taxpayer, setting up a limited company to manage your new buy-to-let property could be a good option.
Natalie Field is an accountant at TaxScouts, a tax management platform
Purchasing with a limited company can give you greater flexibility as you are taxed on the rental profits and then taxed again only when you take money out of the company.
If you’re smart with the timing and how you draw money out (salary, dividends or pension options) this can be a more tax efficient option.
Unlike selling a buy-to-let property as an individual you won’t be charged capital gains tax (CGT), you’ll just pay corporation tax which is charged at between 19 and 25 per cent.
If you’re looking to invest funds into more properties rather than withdraw profits personally, purchasing a buy-to-let property through a limited company can be an attractive option.
However, purchasing as a limited company will likely give you fewer and pricier mortgage options, as providers tend to see limited companies as less favourable borrowers.
Will they be double taxed?
Natalie Field replies: It might seem like double taxation as there are two different taxes, corporation tax and dividend tax.
However, the total corporation tax and dividend tax could still be less than the income tax paid if the properties were personally owned.
How much is paid depends on the individual’s tax rate, and level of money they have drawn from their limited company.
Longer term, you may also want to consider the tax benefits on selling too.
Manjinder Bains adds: Yes, they will pay two lots of tax. They will pay corporation tax on the rental profits and income tax on the dividends.
However, if this person intends to buy more buy-to-lets in the future, then the limited company model could be the better option.
Let me give you a hypothetical example.
If your reader uses a limited company to buy his properties and does not need income until retirement for the most part, he will pay 19 per cent corporation tax each year whilst he builds his rental portfolio.
He will only start paying the income tax when he takes dividends later in life. In the meantime, as he is only paying 19 per cent tax, he can use his surplus funds over time to buy more properties.
For every £1 of rental profit he generates he can save 81p to build his portfolio. Say that, over the next 10 to 20 years, he amasses a portfolio of six rental properties.
When he retires he could have a state pension, a small private pension and his property portfolio.
He now needs to pay income tax at 8.75 per cent, and if the dividends take him over £50,270, the excess dividends over this threshold will be taxed at 33.75 per cent.
Owning in a limited company can result in being able to re-invest quicker and ultimately buy more property
If the reader did the same but owned property personally and was a higher rate taxpayer, for every £1 of rental profit he generates he can save 60p to build his portfolio. If he were an additional rate taxpayer he would only be left with 55p.
Instead of having six properties like he might have accumulated with a company, he has only been able to amass a portfolio of four rental properties.
Owning in a limited company can therefore result in being able to re-invest quicker and ultimately buy more property.
So even factoring in the double taxation consideration, the limited company client will have more profits from his six properties than his counterpart with four, and so it will usually always be worthwhile for portfolio landlords to own their properties using a limited company.
However, of course, the results are less advantageous if you take the profits from the company as you go along to supplement your personal income.
Landlords who own buy-to-let properties in their own name rather than via a company now pay tax on their entire rental income, rather than their profit after mortgage interest is paid
Should they move their existing buy-to-let into a company?
Natalie Field replies: If you’re considering moving your existing properties into your limited company, you may face some complications.
You’ll have to sell the property as an individual seller to your new company, meaning you’ll likely pay capital gains tax, stamp duty and the associated legal fees that come with being an individual seller.
In many cases, our customers find this ends up being too costly and not worth it.
Are limited company mortgages more expensive?
Chris Sykes, associate director at mortgage broker, Private Finance, says limited company mortgages are more expensive, but he thinks the gap could close in future
Chris Sykes replies: If you split the fees over the term and put that into the rate, effectively it is often between 1 per cent and 2 per cent more in rate to do it through a company.
You will often get lower rates but extreme fees with more specialist and portfolio lenders that you wouldn’t get through personal names.
However, on houses of multiple occupation and multi-unit freehold blocks, the rates are fairly comparable as you are already going to a specialist lender.
The gap in pricing between limited company and personal name buy-to-let mortgages has reduced over the years, but not by that much.
It might reduce further if major high street lenders start offering limited company mortgages, which we have seen some start to do.
I am reliably informed that limited company mortgages is an area we are likely to see grow in future years, which will close the gap further.
How much higher are fees for limited companies?
Chris Sykes replies: A lot of lenders have gone with adding say a 5 per cent product fee on a 5 year fixed, to bring down the interest rate and stress rates by 1 per cent per year.
Other costs are higher too. These include legal fees, often there are valuation fees, accounting fees, business banking fees, etc.
How much are accountancy firm fees?
Manjinder Bains replies: Different firms have different fee structures, so it is hard to find a typical fee as it depends on what you are getting for the service.
We have seen the most basic services for limited companies being offered for £400 plus VAT right the way through to £2,000 plus VAT.
Some of this is geographical. Clients in London and the southern counties can expect to pay more for the same service compared to clients in the Midlands and further north.
Can they mitigate inheritance tax?
Manjinder Bains replies: Under normal circumstances the options are very limited and it is usually simply a case of choosing to either pay 28 per cent capital gains tax when gifting the properties to the children for free, or accepting your fate and paying inheritance tax at 40 per cent on the market value of the property on death.
The first option is usually preferable out of the two options, albeit neither is great.
However, many landlords rely on their income from their rental properties as their pension and so the cheaper option may not even be possible.
Factor in accountancy fees: The most basic services for limited companies are offered for £400 plus VAT right the way through to £2,000 plus VAT, according to one expert
However, if you use a limited company and it’s set up correctly from inception with your children included, it is possible to save large amounts of inheritance tax in the future without giving up the rental income.
The company needs to be set up in what is known as a family investment company to achieve this, as a standard limited company does not offer this advantage.
It is quite complex, so it would be worth speaking to a tax accountant who specialises in this area before making any decisions.
It could also be possible to add the children as shareholders at a later date in order to benefit from inheritance tax savings. Once again though, speak to a qualified tax advisor.
Can you explain how this works in reality?
Manjinder Bains replies: The solicitor will need to value the shares on death. If they have used the model of saving inheritance tax by adding the children at inception, the value of those shares will not be based on the market value of the properties at the date of death, but the market value of the properties when they were first acquired by the parents.
Therefore, the house price growth from the date of ownership to the date of the last surviving parent is protected from inheritance tax, as the growth is considered to be passed to the children via their shares. This results in large inheritance tax savings for the families which implement this successfully.
Let me give you an example. The company is set up with a husband and wife and their two children.
The company is set up with what we refer to as alphabet shares. If there are four members of the family, for example, there will be A,B, C and D shares.
The parents get the A and B shares between them. They will typically form 96 per cent of the shares. The children will be allocated the C and D shares.
However, their share rights are voting and dividend rights only, so they are not entitled to return of capital.
The children’s shares are non-voting, but are dividend and return of capital shares.
The effect of that is the parents’ shares are frozen in value from day one at what their nominal value is.
We then assume that the parents will leave their voting shares to their children in their wills. Then, the children acquire control of the company and avoid any inheritance tax.
Think ahead: If a limited company is set up correctly from inception with children included, it is possible to save large amounts of inheritance tax
What if they sell properties to fund their retirement?
Manjinder Bains replies: If they sell the properties and want to take the cash out of the company to fund their retirement, they may end up paying more tax overall than if they had owned the properties personally.
After paying corporation tax at 19 per cent they would be able to take out any remaining directors loan account funds tax-free but would then pay income tax on the dividends.
However, depending on the amount of directors loan account remaining, it’s not necessarily always the case that the taxes combined will amount to more than the 28 per cent capital gains tax that would be payable if the landlord was a higher rate taxpayer.
Also, if the property was in the company for say 10 years the landlord may have had an income tax saving of 21 per cent each year for a 10-year period, which also needs to be taken into consideration.
As a general rule of thumb, the longer the length of ownership the better off they are in a limited company, and the shorter the length of ownership may favour personal ownership.
However, it’s worth pointing out that the capital gains tax annual exemption is falling to £3,000 from next year, which impacts those who sell property held in their personal names.
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