Since April 2020, property landlords can no longer claim mortgage interest relief at higher tax rates from the rental income to reduce their tax bills. Relief is now limited to the 20% basic tax rate. This change has resulted in landlords seeing a considerable reduction in their after-tax profits.
With tax benefits and potential savings, many property landlords are considering setting up a limited company to grow their property portfolios. Before making the decision, it's important to look at the advantages and disadvantages of becoming a limited company:
- Potential Tax Savings
The corporation tax rate is currently 19%. This means your tax liability is reduced in comparison to if you're paying income tax as a higher rate taxpayer (40%). If you need to draw the rental income, the limited company route may not be suitable. This is because income tax is payable on withdrawals of these funds.
If funds are retained in the company, you can control how much income is taken personally, potentially reducing your income tax liability.
- Reduced tax on dividends <£2,000 for individuals
There is currently a tax-free Dividend Allowance of £2,000 pa per person, meaning you could potentially receive tax-free dividend income from your investment properties. Dividends above £2,000 up to the top of the basic rate tax band (currently total income up to £50,270 in 2021/22) are taxed at 7.5%. This rate is much lower than the basic income tax of 20%.
- No income tax when retaining profits to secure further properties
You can grow your BTL portfolio quicker within a limited company as there will be no income tax on the retained profit. This allows more cash for re-investment. Although corporation tax is payable on company profits (19%), this is lower than the higher income tax rate (40%).
- Personal funds can be drawn back out of the company
Any investment you make into the limited company, such as the mortgage deposit, can be withdrawn from the company tax-free if it is classed as a Director's Loan.
- Change of Ownership
The limited company will own the property. However, the company directors or shareholders can be changed quite easily. You can, therefore, add or remove owners to suit your situation.
Changing ownership via share transfers is simpler than changing ownership of a property by sale. However, capital gains tax may be payable on the value of shares transferred, so advice must be sought.
- Inheritance tax planning
If you plan to hold the portfolio over a long period, it may be possible to pass ownership of the properties in a tax-free manner through planned share transfers to your family. This can assist with reducing inheritance tax in the long term.
- Limited liability
If you buy to let as a limited company, your investment property becomes legally separate from your personal affairs. This limited liability essentially means you are not personally liable for any losses made in the property business. This is unlikely unless you could not keep up with mortgage payments and experienced cash flow issues.
- No Capital Gains Tax (CGT) allowance when the company sells a property
There is no personal capital gains tax when a company sells a property, whereas individuals selling a property would have a £12,300 CGT allowance (2021/22). With joint ownership, this would be a £24,600 tax-free gain.
- Property Transfer Costs
If you want to transfer existing properties into the limited company, you will incur stamp duty land tax, legal costs, and potentially capital gains tax.
Potential capital gains tax must be calculated if you plan to transfer properties you already own into a limited company. Your accountant should complete this in order to establish a cost-benefit analysis to compare the costs and potential savings.
- Administrative costs
Setting up and running a limited company is not to be taken lightly. Making this change can mean you find yourself spending time and money keeping your company on the right track.
Once you've set up your company, you (or your accountant) will have to prepare and submit detailed accounts, company tax returns and corporation tax calculations to HMRC. There are also additional accountancy costs in order to operate through a limited company.
- Higher Mortgage Rates
Most mortgage lenders charge higher interest rates and fees for limited companies than they do for individuals. A cost-benefit analysis should be completed to compare the increased mortgage costs compared to the potential tax savings.
- Reduced Lender Choice
Many lenders are happy to lend for buy to let purposes in your personal name, however, some of those lenders currently do not offer buy to let mortgages to limited companies.
- Higher Legal Costs
Conveyancers may charge extra fees for limited companies due to the extra workload involved. These extra tasks for conveyancers include registering mortgages at Companies House and ensuring money laundering regulations are met.
Your personal property accounts and tax documents are between you, your accountant and HMRC. A limited company has to publish its accounts which are then made available online at Companies House. These reveal some financial insight about the company's financial status to the public.
- Releasing Equity
Landlords have previously enjoyed releasing equity from a property on refinancing, especially in areas of good capital appreciation. With limited company property, you can still release equity, but those funds belong to the company. If you want those funds personally they will be classed as income and taxed appropriately.
The limited company route is more likely to be suitable to higher rate taxpayers who have a plan to build a portfolio and retain these properties long term.
Professional advice must be sought from an experienced accountant before making this decision. If you're a Huddersfield based property landlord looking for advice, contact our team of experts today to find out how we can help.