Over the years, there has been a sizeable shift toward purchasing investment property, essentially ‘buy to let’ property, through limited companies. This shift has been driven primarily by the desire for both homeowners and landlords to reduce transaction costs, and it seems that the primary impetus behind this development falls mainly down to the recent changes and new rules governing tax relief for mortgages.
Back in 2015, these were first executed by George Osborne, who served as chancellor of the exchequer. They were implemented on a tiered system with the intention of reducing the number of individuals operating as private landlords in the United Kingdom.
The situation evolved to the point where, at the beginning of April 2020, private landlords would no longer be able to deduct any mortgage payments from the income they get from their rentals to lower their overall tax liability.
Because of this, landlords saw a significant decrease in their after-tax profits; in the case of some landlords in central London, this reduction has been as high as forty percent.
Although some landlords did leave the industry because of Mr. Osborne’s policies, it did not have the effect that he had hoped for.
This is due to the fact that a large number of individual landlords who own a small number of buy-to-let properties converted their tax filing status from that of an individual to that of a company. In this sense, they would be considered to be making corporate tax payments.
And, because limited companies are able to treat mortgage interest as a cost, and because the rates of corporation tax and dividend tax are significantly lower than the rate of income tax for higher-rate taxpayers, it made sense for a large number of private landlords to go this route.
Even in today’s market, a significant number of landlords are thinking about becoming a private individual investor in property by forming a limited company rather than paying tax as a private individual.
If this is the case, you should consider carefully weighing the benefits and drawbacks of the situation before settling on one option over another. This is the case because, much like other aspects of life, nothing is ever as simple as black and white; for example, forming a limited company to invest in buy-to-let real estate comes with both positive and negative aspects to consider.
We have listed both sides of the argument below in an effort to help you decide whether it is beneficial for you to purchase homes and apartments through a limited company in order to rent them out and save money on taxes given your specific circumstances.
The Benefits of Purchasing Through a Limited Company
Tax treatment of profits
The profits that private landlords make from rental income are subject to income tax, just like the rest of the income they bring in. That means adding the money you make from rental income to the amount of money you make from a salary, as well as any other money you make from dividends or shares of stock. The following tax brackets apply if you have income that is in excess of your personal allowance. At this time, the standard personal tax-free allowance is £12,571; however, this amount decreases if your income is greater than £100,000.
|Tax Band||Income||Tax Rate|
|Basic Rate||£12,501 to £50,000||20%|
|Higher Rate||£50,001 to £150,000||40%|
|Additional Rate||over £150,000||45%|
If you make your real estate investments through a limited liability company, the profits from those investments will be subject to corporation tax. The current rate of the corporation tax is 19 percent, but it is scheduled to increase to 25 percent by the year 2023.
If you are a taxpayer who pays at a higher rate, you have the potential to save a significant amount of money on your taxes.
If you want to access the income from your rental property, you will still be subject to taxation, either in the form of income tax on the salary you pay yourself or tax on dividend payments. More on this will be covered in a later section when we discuss the tax that you’ll have to pay when you withdraw money from your company. On the other hand, there are ways in which an accountant who specialises in can reduce the amount of tax that you owe.
Tax treatment of mortgage interest
It is no longer possible for private landlords to deduct any of the costs associated with their mortgage from rental income in order to lower their tax liability. Instead, they are eligible for a tax credit equal to twenty percent of the amount of interest they have paid on their mortgage. Because the credit only reimburses tax at the basic rate and not at the higher rate that you paid, if you are a taxpayer who pays tax at an additional or higher rate, you will not get a full refund of the tax that you paid on your mortgage payments. Because you will be required to report on your tax return the income that was used to pay the mortgage, it is possible that this will cause you to be placed in a higher tax bracket than you were previously.
This is a problem that is faced by a significant number of real estate investors, and it is one of the primary reasons why it was prudent to form a limited liability company rather than pay tax in a higher band.
Because mortgage interest is considered a business expense for properties owned by limited companies, whereas it is not for properties owned by individual investors, forming a limited company becomes a much more appealing option. Because of this, it is possible to take a deduction for the amount of interest paid on a mortgage before making a payment on your corporation tax.
Inheritance tax benefits
By purchasing real estate through a limited company, landlords who intend to eventually hand down their property portfolio to their children or other members of their family are able to avoid paying significant amounts of inheritance tax. This is due to the fact that they are eligible to claim Business Property Relief (BPR) on both their income and their assets. Property investors have had the ability to hold shares that qualify for Business Property Relief in a tax-efficient ISA account since 2013. This privilege was granted in 2013. Due to the fact that their shares are traded on the stock market, public companies are unable to gain access to this BPR. At the same time, sole traders, also known as self-employed property investors, are not permitted to use it if they intend to transfer fixed assets such as a building, land, or machinery. To put it another way, this is a type of tax relief that is catered specifically to limited companies.
Disadvantages of Buying through a Limited Company
Mortgage financing may not be as readily available when purchasing through a limited company.
When compared to those available to individuals, the number of buy-to-let mortgage products available to limited companies is significantly lower. Because of this, obtaining a mortgage might prove to be an extremely challenging task for you. On top of that, there is a good chance that the interest rates will also be raised.
Tax when you take money out
You can pay yourself a salary out of the money you make from renting out your property. This will be subject to income tax, but it will be deducted as a cost when you calculate your profit before taxes for the purposes of the corporation tax.
The distribution of rental income in the form of dividends is not considered a business expense. The dividend tax exemption is set at £2,000 for the fiscal year 2022-2023 in the United Kingdom. Your tax bracket determines how much additional tax you have to pay on dividends that are greater than this amount. The following dividend rates apply.
|Tax Band||Tax rate on dividends above the allowance|
This is not an issue so long as you intend to reinvest the profits from the rental into the business. However, if you essentially need the income from your rentals to live, then you will need to do the math to figure out whether or not forming a limited company will reduce the amount of taxes you owe.
Consult a tax accountant because there are ways in which you can capitalise on your tax-efficiency, such as splitting dividends with a basic rate tax paying spouse or partner. However, there are other ways in which you can do this as well.
Transferring any properties you own in your own name is costly
You will need to go through the steps outlined in the applicable legal procedure in order to convert your company into one that has a limited status. This necessitates the payment of taxes as well as fees to the conveyancer. You will, in all actuality, be required to “sell” your properties to yourself. There are expenses associated with this endeavour, some of which are as follows:
- The Tax on Capital Gains: Any profit you make off of your investment in bricks and mortar will be subject to taxation. The amount of capital gains tax (CGT) that you will owe is proportional to the amount of income tax that you pay on an annual basis. Therefore, if you are considered a basic tax payer, your capital gains tax will be calculated at 18 percent, whereas the higher tax rate is determined to be 28 percent.
- Stamp Duty Land Tax – More commonly abbreviated as SDLT, this fee is a standard tax that is calculated based on the value of your property. However, you will be required to pay an additional three percent tax on the profit you make from the investment property because it is not your primary place of residence. This is because it is considered a “second home,” which is a distinct category.
- Fees for conveyancing and solicitors – Just as if you were selling to another person, the standard procedure will apply, which means that a solicitor or conveyancer will be required to ensure that the switch is legal. This is the case even if you are selling to a company.
- Increased mortgage charges and Early redemption charges – Some mortgage lenders charge a nominal repayment fee if you have only just started to pay off your mortgage. This is because they anticipate that you will continue making payments for the foreseeable future. In most cases, this falls somewhere in the range of one percent to five percent.
Because of these costs, converting to a limited company may be very difficult or impossible for certain landlords. For some people, the long-term reduction in their tax burden more than makes up for these costs.
Because annual accounts need to be filed for limited companies, you will need to pay for the services of an accountant. In addition, running a limited company requires a greater amount of paperwork and administration.
- What are the steps involved in establishing a limited liability company?
You will need to decide on a name for your business and register it with Companies House before you can begin.
In order to accomplish this, you will need to:
- appoint at least one director;
- determine who the shareholders are and issue shares;
- prepare a Memorandum of Association and Articles of Association to agree on how you will run your company; and
- issue shares.
The initial registration fee for a new business is twelve pounds. You will be given a certificate of incorporation once the process is complete. This verifies that the company is recognised by the law and displays the company number as well as the formation date.
As a result of the brevity of the process, the time it takes to become incorporated as a limited liability company is typically less than twenty-four hours from the time an application is submitted.
On the website of the government of the United Kingdom, you can find additional information about forming a limited company.
- Will it be possible for my business to take out a loan?
Yes, but you may find that the interest rates are higher than those associated with personal mortgages because lenders view the risk associated with commercial mortgages as being higher.
Expect the loan-to-value percentage to be lower as well. Many lenders require a loan-to-value ratio of 70% for mortgages with repayment and a ratio of 65% for mortgages with interest only. This indicates that in order to qualify for a standard buy-to-let mortgage, you will need to pay a deposit that is significantly higher than what you have done so in the past (usually around 40 percent).
Because companies typically have limited liability, financial institutions are typically more hesitant to lend money to them. If you want your limited company to be eligible for a loan, you should probably be prepared to provide a personal guarantee for it.
- I’m looking to make my first investment in buy-to-let real estate; should I do so through a limited company?
This depends on what your goals are for the future as an investor in real estate. If you only ever plan to rent out one or two properties at the most, forming a limited company is probably not the best route to go down because it is more complicated than it is worth. On the other hand, if this is the first step in what you hope will become a prosperous real estate empire, you should consider forming a limited liability company right away because doing so will likely be less expensive and more convenient.
- If you currently hold real estate in your personal name, should you consider transferring it to a company?
This is something that will be determined by the number of properties you own. For instance, if you only have a couple of properties that you rent out as buy-to-let investments, switching probably won’t be worth it. However, if you have a sizeable portfolio, you should give some consideration to this possibility. Find a good tax accountant, preferably one who specialises in property, and ask them what steps you should take next. They should be able to guide you in the right direction.
You will need to calculate all of the costs, as detailed above, and then evaluate this information in light of the potential tax savings you could realise.