With the impending tax crackdown on individual landlords, many property investors are considering forming limited companies to preserve their income.

Limited company buy to let can be a tax-efficient investment strategy, particularly for larger, more heavily geared landlords. But administering a limited company comes with costs of its own, and the different tax system may not be advantageous in every case.

Background: why are more landlords considering limited companies?

In the summer, the government announced that tax relief on buy to let mortgage interest would be withdrawn between 2017 and 2020 and replaced with a 20% tax reduction. Critics were quick to point out that tax bills were likely to jump for some landlords in the 20% tax bracket, whom the measures were ostensibly designed to ignore, as well as the 40% and 45% taxpayers they targeted.

Also observed was the fact that limited companies, who pay corporation tax rather than income tax, would be exempt from the measures, and would continue to be able to offset their full business costs (www.ft.com).

The months since have seen a growing number of landlords enquiring about limited company mortgages, keen to get the transfer underway before the phase-in of the new rules begins in a little over two years’ time.

The rules could affect a mortgage that you take out now

As the majority of buy to let mortgages have an introductory period of at least two years, any mortgage you take out now is likely to still be in place when the 2017–18 tax year starts.

This could inform many crucial particulars of a mortgage application, such as:

• The mortgage features (whether it imposes early repayment charges or allows overpayments);
• The initial deal period of the mortgage; and
• Whether the mortgage is taken out on an interest only, part-repayment or full-repayment basis

A responsible mortgage advisor will be sure that their client is fully abreast of the wider situation, but landlords should still bear these facts in mind when applying for finance.

What are the advantages of limited company borrowing?

Full tax relief from 2017 onwards

As discussed, entities such as limited companies that pay corporation tax rather than income tax will continue to enjoy full tax relief for buy to let finance costs. Depending on your level of debt, this could lead to significant tax savings.

Lower tax on retained profits…

If you run a letting business as an individual, your rental income comes to you automatically and is subject to income tax in its entirety. If your income is high enough, you could pay 40% or even 45% tax on some of it.

A limited company’s rental profits go first to the company, which is a separate legal entity, and are taxed at the corporation tax rate of 20% (this will reduce to 18% by 2020). Any trading profits left in the company are free to be reinvested as required.

…and more control over taxable income

Dividends allow you to choose how much personal income you take from the company. Currently, basic rate taxpayers don’t pay tax on dividends; from April 2016, everyone will pay tax, but there will be a £5,000 dividend allowance.

It is therefore possible for dividends to be taxed twice, so depending upon a variety of factors including your tax bracket and the amount of personal income you wish to derive from your business, this may not be the most efficient approach.

Director’s loan accounts

Director’s loan facilities, whilst complex, are a good way of tracking cash flow between a company and its owner. They mean that any personal funds put into the company, whether in the form of cash (such as for a deposit) or items you have bought for the company, are yours to take back out – and they are not subject to tax, as they do not represent profit.

More information: www.gov.uk/directors-loans

What are the disadvantages of limited company borrowing?

No personal allowance for capital gains tax (CGT)

Like rental income, capital gains from property disposal are also subject to corporation tax, where individuals would instead pay capital gains tax (CGT).

CGT is levied at either 18% or 28% depending on your tax band, meaning the rate may be lower for a limited company – but unlike individuals, companies do not get an annual personal CGT allowance.

This is one of many examples that demonstrates what is a tax-efficient arrangement for one landlord may not be for another, so it is crucial that you seek professional accounting advice to determine the best route forward.

Company administration costs

Registering and running a company will entail additional costs that individual landlords do not incur, including accounting, auditing and legal costs.

Limited choice of mortgage products

Fewer lenders offer products to limited companies than individuals, and those that do might not extend their entire range.

At the time of writing, just under 6% of the mortgage products that Commercial Trust can access are available to limited companies. Often, corporate borrowers have to seek finance from commercial or specialist lenders; the advice of a professional mortgage advisor is therefore instrumental in helping you get the right loan.

Should I use a limited company to run my buy to let business?

Whether this strategy is the right one for you really depends upon your situation and your plans for the future. You should familiarise yourself with the pros and cons and seek appropriate financial and legal advice before proceeding. You should also decide whether you wish to run your entire portfolio through a company structure, or retain your existing properties in your individual name.

Setting up a limited company for future purchases

Though this option will not affect how you manage or pay tax on your existing portfolio, it could allow you to exercise the desired level of control over future acquisitions.

Once reason to consider this this route is the possibility of releasing capital through the limited company in order to reduce debt outside it. This will maximise the amount of your mortgage interest that can be offset in full, and help you to avoid paying tax on a loss.

There are downsides to this route, however:

• Limited company mortgages might be less competitive, meaning that you pay more to service the debt inside the company than outside it.
• Lenders may penalise you if you reduce too much of your debt in one go, in the form of early repayment charges (ERCs).

Should I transfer my portfolios to a limited company?

This route is far more complex, and whilst it might enable you to exercise the maximum amount of financial control over your investments in the future, the short-term costs might be too high.

Asset transfers between an individual and a company are treated as market-value transactions. Essentially, you would be both the seller and the buyer. This means that you will potentially need to pay CGT on the sale, and stamp duty land tax (SDLT) on the purchase.

The latter tax is especially pertinent, because from April 2016, buy to let purchases will be subject to a 3% surcharge. Only large limited companies – those with more than 15 properties – will be exempt.

Much like purchases, product transfers take around three months to complete – so landlords hoping to transfer their properties before the surcharge comes into effect may wish to seek urgent professional advice.

Choosing to invest as a limited company is an important decision

Though in business it is always important to stay ahead of the curve, it is equally important not to rush crucial decisions.

Some landlords will not see their tax bill affected immediately. The changes to buy to let tax relief will be phased in over a period of four years, and the full effects will not be felt until April 2020.

Landlords should carefully consider the benefits and drawbacks of limited company investment, both for incorporating existing properties and for future purchases, and proceed only with the advice of a qualified tax or accountancy professional.

 

Written by Ben Gosling at www.commercialtrust.co.uk