Over recent years, there have been many changes to how Buy to Let Properties are taxed; removal of the Wear and Tear allowance, changes to stamp duty, changes to treatment of how mortgage interest is treated to name a few.
In light of these changes, many landlords are considering whether or not they should own their properties within a limited company. So what should you consider and is it worth it? Here we discuss three key considerations:
The difference in how profits are taxed
When you own a property personally, you are taxed on the profit you make from renting it out. i.e. the difference between the rental income and your allowable expenses. This profit is added to your other income in the tax year and the tax is calculated. If this takes you over c£43,000 (for 2016/17) then you will pay 40% income tax. When you sell the property, you will pay Capital Gains Tax on any gain you make but can take advantage of your Capital Gains Tax Allowances (2 if it is owned jointly).
If the property is owned by a limited company, you pay Corporation Tax on the rental profits at 19%(2017/18). There is no Capital Gains Tax allowance available so you pay Corporation Tax on the gain.
So far so good, as you pay tax at 19% on your profits, it seems that a Limited Company is the obvious answer; that is until you come to take the money out of the company. In order to take any money out (assuming you haven’t lent any money to the company in the first place to buy the property), you need to declare a dividend and whilst you have no tax to pay on the first £5000 of dividends, (in 2017/18) the remainder is taxed at either 7.5%, 32.5% or 38.1% depending on your highest rate of tax. This means that you have paid Corporation Tax and then personal income tax and so in effect taxed twice.
If you can leave the money in the company and take it when you are paying a lower rate of tax, for example when you are retired, then this may be a benefit.
Tax Treatment of Mortgage Interest
Between April 2017 and April 2020, HMRC are reducing the tax relief you receive on the mortgage interest you pay on your Buy to Let property down to 20%. It will no longer be an allowable expense, rather you get a ‘credit’ equivalent of 20% of the mortgage interest paid.
For example, under the old system, say you had rental income of £10,000 per annum and mortgage interest of £8,000 you would pay tax on the £2,000 profit which, at 40%, is £800. Under the new system you would have profit of £10,000 so pay £4000 tax less 20% of your mortgage interest (£1600) = £2400 tax to pay.
In real terms, you have received the same cash from your tenant and spent the same on your mortgage but now, in this example, you are making an after tax loss of £400.
The calculation for basic rate tax payers remains unchanged, however, be careful as the new profit calculation could move you into the higher rate tax band.
If you own a Buy to Let within a limited company, the mortgage interest payments continue to be an allowable expense as previously. Again, this points towards the fact it is worth changing to a limited company, particularly if you are a higher rate tax payer, however, you need to consider that banks don’t like lending to new limited companies and so how you raise the finance becomes a key consideration.
The additional costs
If you already own a property and are considering transferring it to a limited company you are actually selling it so you need to consider the legal costs, stamp duty, capital gains tax you may have to pay.
Also, running a limited company is more expensive than operating as a sole trader. The requirements are more onerous and complicated so invariably your accountancy bills will be higher and you will have to dedicate more of you time to the administration of your portfolio.
So what is best? Limited Company or personally owned?
As with most things tax related, there is no easy answer. This article only discusses a few of the, albeit major, issues relating to whether it is better to own buy to let property as an individual or in a limited company. At first glance, a limited company seems an obvious choice, however, when you consider the double taxation issues, difficulty in raising finance and the additional cost it may not be. You should always seek advice from your from your accountant or tax advisor so that they can consider all of your circumstances and help you decide what’s best for you.
If you would like help with this or any other tax matters simply get in touch and we would be happy to have a chat.