Getting the right legal structure set up when first investing in property may seem like a daunting process, but in the long run, it can save you tens of thousands of pounds in tax, which is why more and more investors these days are opting for Limited Company structures for their property investments.
Over the past few years, more and more property investors have opted to make their investments through a limited company rather than in their personal names.
The reason for this stems back a few years to the 2015 summer budget when George Osborne, the Chancellor of the Exchequer at the time, thought it would be a smart move to clamp down on ‘non-professional’ landlords by hitting them with tax changes and restricting the limit of relief available on their mortgage interest payments. It was also seen as a way of forcing out the amateur landlords, and potentially making more properties available for first-time buyers, thus assisting with the massive housing crisis and undersupply in the UK.
This tax change is gradually being phased in over the next couple of years, until 2020. Up until then, landlords have been able to declare 100% of their mortgage interest payment as a tax-deductible expense, only paying tax on the remaining balance.
For example, in the past, a typical buy-to-let property would be taxed in the following way:
Your buy-to-let earns £20,000 a year.
The interest-only mortgage costs £13,000 a year.
Tax is due on the difference or profit.
So you pay tax on £7,000, meaning £2,800 for HMRC (if you are a higher rate taxpayer) and £4,200 for you.
With the new tax changes, investors will no longer be able to offset that interest payment. So the same example above would work in the following way:
Tax is now due on your full rental income of £20,000, less a tax credit equivalent to the basic-rate tax on the interest (ie 20% of the £13,000)
So you pay 40% tax on the £20,000 (£8,000), minus the 20% tax credit on the interest (20% of £13,000 = £2,600), meaning £5,400 for HMRC and £1,600 for you.
Your tax bill has just gone up by 93%!
Imagine a scenario where the interest rate rises slightly… increasing your mortgage cost to £15,000, while your rent remains at £20,000.
You will have to pay £5,400 tax in this scenario, so you make zero profit at all!
With limited companies, you can still claim your mortgage interest payments as an expense, and as you can see in the above example, you can immediately save a few thousand pounds a year by being structured in this way, especially for those investors looking to build a substantial portfolio, the level of savings could end up being in the tens, or even hundreds of thousands of pounds a year.
Not only is this a huge advantage over privately owned buy-to-let properties, but the other major advantage is also that the level of tax payable on the actual profits (the remaining funds left AFTER the mortgage payments), the rate of tax is lower than if it was owned in your personal name.
If you’re a higher rate (40%+) taxpayer, then there’s an even greater reason to incorporate your investments, as the tax payable is only 20% on the profits (corporation tax – this is the tax on the company profits). Corporation tax is also set to decrease over the next few years, bringing it down further to 17% by 2020. So you’re paying just 17% on the profits, which is a huge saving compared to paying 40%+ on the full amount of rental income.
You will still be taxed on the dividends you receive, but there’s flexibility with when you take these dividends for more tax efficiency, you can also distribute to other people – perhaps family members who are lower rate taxpayers, or alternatively leave the net profits in the company and use those funds to keep buying more properties and growing your portfolio faster.
The third major reason investors are choosing limited companies is due to inheritance tax. You can use trust structures, different types of shares, and other alternative ways to mitigate the level of inheritance tax paid by those inheriting your estate should you pass away.
There are, however, some minor drawbacks of investing through a limited company.
Mortgages – there are currently fewer mortgages available for limited companies than what is available for those investing in their personal name. This is changing slowly, with more lenders coming to the market each year. The rates of interest are usually slightly higher when investing through a company too, so it’s worth factoring this in when doing your sums.
You will also be required to give a Personal Guarantee, or Directors Guarantee – essentially agreeing that if the company was struggling to repay the mortgage, then you as the Director of the company, agree to repay the mortgage. So although the company is called a ‘Limited’ company…the same level of risk applies to if you owned the property in your personal name. Think of it as a ‘tax wrapper’ rather than an entirely separate entity.
More paperwork – as you are running a company, there is, of course, more paperwork involved – you have to file an annual return, and annual accounts with companies house – not a major stress if you have an accountant who can take care of it for you. Of course, you’ll need to pay them for this…extra cost, but it’s a business expense.
Dividend Tax – finally, there’s the issue of taking the money OUT of the company through dividends and paying tax on that. This is after you’ve already paid corporation tax, so you’ll save some tax on the front end, but then pay more on the back end when you take it out of the company, so you will need to work out which option saves you the most amount of money.
And the best way to do this is to speak to an accountant or tax advisor!
We are not a specialist advisor but can pass you on to a number of advisors who are currently assisting many of our clients, so get in touch today for more details to ensure you are getting the right advice, and setting up the right structure before making any decisions on investments.
*It is strongly advised you seek professional tax advice regarding investing through a limited company structure as we are not qualified to give tax advice.
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