There has been an upsurge of people buying property though a limited company. This increase of demand is a result of changes to the mortgage tax relief rules. This is also covered in the article What is buy-to-let mortgage interest tax relief? And how does it affect me?
George Osborne introduced these rule changes in 2015. His aim as chancellor was to reduce the number of private landlords in the UK. They were introduced on a sliding scale. By April 2020, private landlords could no longer deduct any mortgage expenses from their rental income to reduce their tax bill. This has resulted in landlords seeing a considerable reduction in their after-tax profits.
Whilst some landlords moved out of the industry, the mortgage tax relief rules didn’t have the intended effect Mr Osborne was aiming for. This is because lots of individual landlords with only a handful of buy-to-let properties changed to register their properties as a company instead of an individual.
And, because limited companies can treat mortgage interest as a cost and corporation tax and dividend tax rates are much less than the income tax rate for higher-rate taxpayers, it made sense for a lot of private landlords to restructure as a business. Many landlords today consider setting up a limited company at the outset instead of paying tax as an individual property investor.
However nothing in life is clear cut. There are both advantages and disadvantages to becoming a limited company when investing in buy-to let-property. This article attempts to show you the pros and cons of both structures.
ADVANTAGES OF BUYING THROUGH A LIMITED COMPANY
Tax treatment of mortgage interest
As discussed earlier, private landlords can no longer deduct any of their mortgage expenses from rental income to reduce their tax bill. Instead, they receive a tax-credit, based on 20 per cent of their mortgage interest payments. If you are a higher rate taxpayer you won’t get all the tax back on your mortgage payments as the credit only refunds tax at the basic rate and not the top rate you paid.
Additionally, you may also find yourself pushed into the next tax bracket because you will need to declare the income that was used to pay the mortgage on your tax return. This has been a common problem for many property investors and is it why it made more sense to become a limited company, instead of paying tax in a higher band.
Limited company status becomes much more attractive because, unlike property owned by an individual investor, mortgage interest is treated as a business expense for limited companies. This means it’s possible to deduct the cost of mortgage interest before paying your corporation tax.
Tax treatment of profits
For private landlords, profits from rental income are taxed via income tax alongside their other earnings. That means adding the money made from rental income to the amount you receive from a salary, as well as any other money received from shares or dividends. Income above your personal allowance is taxed at the rates listed below. Currently, the standard personal tax-free allowance is £12,571 (although this reduces if your income is over £100,000).
| Tax Band | Income | Tax Rate |
| Basic Rate | £12,571 to £50,270 | 20% |
| Higher Rate | £50,271 to £150,000 | 40% |
| Additional Rate | over £150,000 | 45% |
If you invest in property via a company with limited status, you will be liable for corporation tax on your profits. The corporation tax rate is currently 19 per cent, but is set to rise to 25 per cent by 2023.
If you are a higher-rate taxpayer you stand to make an huge tax saving.
You will still be taxed if you want to access your rental income, either via income tax on the salary you pay yourself or tax on dividend payments. However, there are ways a tax accountant can minimise the tax you pay.
Inheritance tax benefits
Landlords planning to pass their property portfolio down to children or family members could avoid large amounts of inheritance tax by buying the property through a limited company. That’s because they can apply Business Property Relief (BPR) to their income and assets.
Since 2013 property investors have been allowed to hold shares which qualify for Business Property Relief in a tax-efficient ISA account. Public companies can’t access this BPR because their shares are listed on the stock exchange. At the same time, sole traders (ie self-employed property investors) are forbidden from accessing it if they plan on transferring fixed assets, such as land, premises and machinery. In other words, this is a form of tax relief specifically aimed at limited companies.
DISADVANTAGES OF BUYING THROUGH A LIMITED COMPANY
Mortgage availability
The number of buy-to-let mortgage products on offer for limited companies is far lower than for individuals. Lenders also don’t lend on the same LTVs as they consider lending to a business as a higher risk. As a result, you may find it much more difficult to arrange a mortgage. And if you can, the interest rates will probably going to be higher.
Tax when you take money out
To access your rental income, you can pay yourself a salary. This will be liable to income tax but will count as a cost when calculating your pre-tax profit for corporation tax purposes.
Rental profits taken as dividends are not considered a business expense. For tax year 2022-2023, the tax-free allowance on dividends is £2,000. How much tax you pay on dividends above this amount depends on your tax band. The following dividend rates apply.
| Tax Band | Tax rate on dividends above the allowance |
| Basic Rate | 7.5% |
| Higher Rate | 32.5% |
| Additional Rate | 38.1% |
If you plan to leave the rental profits in the company, this is not a problem. However, if you need to live off your rental income (which many small-scale landlords do), then you will need to do the maths to work out whether a limited company reduces your tax bill. Speak to a tax accountant as there are ways you can maximise your tax-efficiency, such as splitting dividends with a spouse who is a basic rate taxpayer.
Transferring any properties you own in your own name is costly
In order to switch your company over to one with a limited status, you have to go through a prescribed legal process. This involves paying taxes and conveyancer fees. Effectively, you have to ‘sell’ your properties to yourself. Naturally, there are costs involved in this, such as:
- Stamp Duty Land Tax – This is a standard charge based on your property’s worth. But in addition, because the investment property isn’t your main residence, you will also be due to pay a further three per cent tax. That’s because it comes under the ‘second home’ category.
- Capital Gains Tax – Any profit you make on your bricks and mortar investment will accrue tax. The amount of CGT you will pay is dependent on how much income tax you pay on an annual basis. That means if you’re a basic tax payer you’ll pay 18 per cent CGT, whereas the higher tax rate is calculated at 28 per cent.
- Conveyancing and solicitor fees – Just as if you were selling to another individual, the standard procedure will apply ie a solicitor or conveyancer will be required to ensure the switch is legal.
- Early redemption charges and increased mortgage costs – Some lenders will charge a repayment fee if you have only just started paying your mortgage off. This is typically between one per cent and five per cent.
For some landlords, these costs make moving to a limited company very prohibitive. For others, the long-term tax savings far out-weigh these costs.
Extra cost and hassle
Limited companies have to file annual accounts, so you will need to pay an accountant. Running a limited company also requires more administration and paperwork.
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FIND OUT MORE
If you are thinking of buying an investment property, it is advisable to understand the best way to structure your investment. When you speak to Esper Wealth, we will help you make an informed decision as to what is right for you. Here are some Common Questions About Purchasing Property Through A Limited Company. This may help you if you are thinking of buying a property via a limited company. Check out the latest tax rates from Tax Rates and Useful Tax Links 2022/23 or alternatively you can download our tax card, which is located in guides section.
