There is a growing preference for limited companies as revised buy-to-let tax (BTL) rules take effect.
According to the Financial Times1, the use of limited companies to hold buy-to-let properties is becoming more popular. This is due to changes in tax policy that saw gradual reductions to higher rate income tax rate relief on buy-to-let-mortgage interest. Choosing to own a buy-to-let property through a limited company is driven by tax-efficiency.
Before April 2017, a landlord who owned BTL properties in their own name was able to deduct mortgage interest from the rental income before paying income tax. We take a brief look at the tax changes below:
A quick overview of the buy-to-let tax changes
- From 2020, landlords will only be able to get tax relief at the basic rate (20%) against the cost of their mortgage interest from their rental income when working out the amount of tax that they owe, not the full 40%-45% relief that higher/additional rate payers currently receive
- Tax will be paid on the turnover that a rental creates, instead of the profit, so tax could potentially be due on non-existent income
- For higher-rate taxpayers, if the mortgage costs over 75% of the rental income, the buy-to-let investment is likely to become loss-making
- The 10% Wear and Tear Allowance will no longer be available in 2020
Because the reductions to higher rate income tax rate relief on buy-to-let-mortgage interest are tapered, landlords are slowly but steadily losing this once valuable benefit. In fact, by 2020 all rental income will be liable for income tax unless the property it relates to is owned through a limited company.
How choosing to own BTL properties through a limited company can help?
The buy-to-let tax rule doesn’t apply to businesses. That is why limited companies are not affected by the new rules that came into force from April 2017. Interest for limited companies is classed as a business expense and is fully deductible against income tax.
Companies pay corporation tax at a fixed-rate, irrespective of the size of the profits. The Corporation Tax rate is currently at 20% reducing to 17% in 2020. This is far more attractive when compared to the 40% for higher rate tax-payers and 45% for additional higher rate taxpayers.
Are there costs involved with setting-up a company?
Yes, existing property owners looking to transfer a current BTL property into a limited company would typically need to ’sell’ their current Buy-to-let properties to their new company at market rate, because if it is in a partnership you can ‘naturally progress’ the partnership into a LTD company and avoid stamp and capital gains tax (CGT).
Attracting capital gains tax on any increase in value of the property. Then on top of this, the limited company would also need to pay the 3% of extra stamp duty levied on second homes. For new purchases, buying in a limited company is likely to be worth considering for anyone who’s likely to exceed the basic-rate tax band.
Due to the complexities in this area we recommend that landlords seek proper professional advice before making the decision to move to a limited company structure.
What else needs to be considered when setting up a company?
Taking money out of the company
There are other questions and costs to consider when setting up a limited company, for example how is the money in the company is passed to the individual? The money can be taken out of the company as a dividend, but only the first £5,000 of dividend income is tax-free. Any dividends taken out above this amount this will either be charged at 7.5% for a basic-rate taxpayer, 32.5% for a higher-rate taxpayer or 38.1% for an additional higher rate taxpayer. This tax is after the corporation tax at 20% has been paid.
The money could be taken as a salary, but the company would have to operate PAYE and pay Employers National insurance contributions. In some cases, this can work out more expensive than paying dividends.
If you are planning on selling the properties on it is worth remembering that companies do not benefit from the £11,000 annual capital gains tax allowance. As a limited company, 20% corporation tax on any gain made from the sale of a property must be paid, then you would pay tax to extract the money from the company. It is worth noting that this will reduce from 20% at the moment to 17% in 2020.
If you’re looking to sell your BTL properties in the near future its worth doing your sums. It could work out to be less tax-efficient than if you were holding the property as an individual. Even a higher rate taxpayer only pays 28% on any gain from the sale of a buy to let as an individual.
Companies are also required to prepare accounts to be filed with company’s house, and prepare and file corporation tax returns which can be more onerous than self-assessment returns.
Interest rates charged on mortgages to companies (commercial mortgages) have historically been higher than to individuals, so further investigation of the comparison of the rates charged should be considered alongside the tax implications.
Should you set-up a limited company for your buy-to-let?
A limited company, or a Limited Liability Partnership may be a more tax-efficient way of owning buy-to-let properties. Your solicitor and/or accountant will be able to advise on the most appropriate business structure on a case-by-case basis. They will also be able to offer guidance on the financial implications of each scenario in greater depth, including the tax liabilities.
Due to the complexities of this area it is essential that you seek proper professional advice.
The information provided in this guide is of a general nature. It is not a substitute for specific advice on your own circumstances. You are recommended to obtain specific professional advice from a tax and legal adviser before you take or refrain from any action. Whilst we endeavour to use reasonable efforts to provide accurate, complete, reliable, error free and up-to-date information, we do not guarantee that it is such.
The information can only provide an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Jan 2017.
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