Buy-to-Let – Use a Limited Company or Not?

Many landlords are grappling with the choice of buying properties in their individual names or via limited companies. The real concern here is the tax implications and financial incentives. The Daily Mail’s financial expert unravels some of the complexities, shedding light on the options available and how they affect both the landlord, and your retirement plans.

The Property Investment Conundrum

The focus is based on a question by a landlord grappling with the decision between buying a second property in his personal name or using a limited company. His main concern is the possibility of being double-taxed in the case of a limited company. He wonders if the seeming higher mortgage costs associated with limited companies could be offset against tax. At the same time, he considers the alternative option of channeling his rental profits into his pension if he decides to buy the property in his own name.

This individual, like many others, sees property investment as not just a means to secure his retirement, but also as a potential inheritance for his children. With one buy-to-let property under his belt and earning around £60,000 annually, plus an extra £11,000 from his current investment, he still worries about increased tax burdens, especially inheritance tax, if he does not adopt the limited company structure.

A Shift in Buy-to-Let Property Purchases

It appears our friend is not alone in this property investment conundrum. There has been a surge in landlords buying properties via limited companies rather than in their personal names. This is largely driven by the lower corporation tax rates and the ability to offset all mortgage interests against their rental income before tax obligations.

This tax relief method, albeit beneficial, differs for landlords who dwell on personal ownership. They only enjoy a 20% tax relief on their mortgage interest payments – a far cry for higher-rate taxpayers who used to receive a 40% tax relief on mortgage costs before the 2016 rule change.

Rates and Implications of Corporation Tax

Corporation tax rates are pretty straightforward. For a company that records over £250,000 as profit, a 25% corporation tax rate is applicable. However, profit of £50,000 or less attracts a ‘small profits rate’ of 19%. And as a middle ground, there’s what we call ‘marginal relief’ for profits between £50,000 and £250,000. Keep in mind though that the £50,000 and £250,000 thresholds could be reduced proportionately for short accounting periods and based on the total number of ‘associated companies’ your company has.

By leveraging the potential benefits of owning rental properties under a limited company, landlords are able to invest faster into additional properties than they could have done if they bought property in their personal names.

Considering Mortgages and Company Structures

With the average two-year fix now reportedly at 6.48%, the cost benefit of holding properties in a limited company has risen significantly. But the catch is that taking advantage of this model depends largely on the landlord’s specific situation.

For instance, lower-rate taxpayers, especially those without huge mortgages on their buy-to-let properties, might be better suited to keep their properties in their personal names. On this note, it is significant to note that owing to the perceived risk, lenders tend to offer fewer and more costly mortgage options to limited companies. Buying a property via a limited company also involves some degree of bureaucracy – formal account preparation and filing, record-keeping and director appointments are tedious tasks a landlord has to handle.

In light of these factors, we sought out advice from three distinguished financial professionals – Manjinder Bains, a chartered tax advisor at UK Landlord Tax, Natalie Field, an accountant at TaxScouts, and Chris Sykes, technical director at mortgage broker, Private Finance.

The Bright Side of Buying as a Limited Company

As per advice from Natalie Field, it could be quite advantageous for a higher rate taxpayer to set up a limited company for managing a new buy-to-let property. Purchasing property with a limited company offers greater flexibility as you are only taxed when you remove money from the company. And if you carefully plan how you withdraw your money, either as salary, dividends or pension options, you stand to gain a more tax efficient deal.

Keep in mind though that as a limited company, you will not be charged capital gains tax (CGT) when you sell your buy-to-let property, you’ll just have to pay corporation tax which is charged at between 19 and 25%.

Dealing with the Fear of Double Payment

The fear of being double taxed under a limited company model is not unfounded. If you are given to think this way because of the two-pronged tax – corporation tax and dividend tax, don’t fret quite yet. Field explains that the combined corporation and dividend tax could still be lower than the income tax if the properties were personally owned.

However, how much you cough out in tax depends on your tax rate and the level of money you have pulled from your limited company. If you have a long-term view to your property investments, you may want to look into the possibility of adding your children as shareholders at some point to gain from inheritance tax savings. A word of caution though, you should seek the advice of a qualified tax adviser before proceeding with this.

Shifting from Personal to Limited Company Ownership

If you already own properties in your name and hope to move them into your limited company, you must be prepared for some possible hitches. In trying to sell the properties as an individual seller to your limited company, you’d be caught up in the web of several financial burdens such as capital gains tax, stamp duty and other accompanying legal fees. As many have found out, this move is usually expensive and not worth the stress.

The Cost Implications of Limited Company Mortgages

Contrary to what some might think, mortgaging a property in the name of a limited company is more costly. Limited company mortgages attract higher fees which could range from legal to valuation fees, accounting as well as business banking fees. However, on properties involving multiple occupation and freehold blocks, the rates are rather comparable.

Even so, Sykes suggests that the disparity in pricing between limited company mortgages and personal name buy-to-let mortgages, might close up in the future if major high street lenders kickstart the offering of limited company mortgages.

Limited Company Fees for Accountancy Firms

The accountancy firm fees for limited companies vary from firm to firm. However, hold on to your hat because the most basic services for limited companies can go for anything between £400 plus VAT and £2,000 plus VAT, depending on the geographical location and the services offered.

Inheritance Tax, Anyone?

For most average landlords, the options for escaping inheritance tax are rather limited. You may either go with the option of paying 28% in capital gains tax when you pass on properties to your children or accept paying 40% inheritance tax on the market value of your property at death.

But good news. If you establish a limited company with your children included and structure it correctly, you can save a great deal in inheritance tax without giving up your rental income. Your company, however, must be explicitly set up as a family investment company as a standard limited company would not offer this advantage.

The Retirement Angle

Yet, if you end up selling your properties to fund your retirement, using a limited company ownership model might lead to you paying more in tax than if you had owned the properties personally.

This conclusion is hinged on the possibility of you paying 19% corporation tax, before taking out remaining director loan account funds tax-free and then paying income tax on the dividends.

However, depending on the prevailing circumstances, you might not always end up paying more in taxes as compared to the 28% capital gains tax rate levied on higher rate taxpayers.

Finally, remember that it’s all about the duration of ownership. The longer you keep your properties under a limited company, the better off you are, while the converse is true for short-term ownership. However, bear in mind that from next year, the capital gains tax annual exemption will be reduced to £3,000. But this law only applies to properties held in personal names.

With all this information on hand, we hope that the decision-making process will be smoother for you. Remember that each scenario is unique, so it’s always best to seek professional advice tailored to your specific circumstances. Oh, and don’t forget to enjoy the adventure of property investing!