If you own or are considering acquiring one or more buy to let properties, you will be thinking about buy to let properties taxation. This includes whether you should purchase the properties in your own name or through a limited company. Incorporation may seem more attractive following the announcement of tax relief restrictions on mortgage interest incurred on personally owned rental properties.
From 6th April 2017, the amount of relief available for mortgage or loan interest paid is progressively restricted. By 5th April 2020, interest will not be allowable in calculating taxable profit, but the resulting tax liability will be reduced by 20% of the interest paid.
If you are debating incorporation, what are some factors you should consider?
Companies and individuals pay different rates of tax. Companies pay a flat rate of 20% tax on their profits (with this rate set to decrease slightly over the next few years) whereas individuals pay different rates of tax depending on their income level. The basic tax rate is 20% (for income up to approximately £42,000), and 40% tax is due on profits above this, with earnings over £150,000 attracting additional rate tax of 45%. There is no national insurance due on rental businesses.
The changes to the mortgage interest tax relief referenced in the introduction mean that profits are calculated before deduction of any mortgage or loan interest. Only after the tax has been calculated – which could well be in the higher rate tax bracket – is 20% tax relief given for mortgage and loan interest.
Overall, this means that companies are likely to have lower tax bills for rental businesses as opposed to individuals. The possibility of higher post-tax profits is very attractive to a landlord who is wanting to use the company profits as capital to purchase more property.
On the other hand, landlords drawing profits from a limited company will have to pay personal tax on the monies drawn. This will, of course, increase the overall tax bill – particularly given the new dividend tax being imposed from April 2016.
Sale of properties
Tax is payable when a property is sold, whether it is sold by a company or an individual. Tax is also payable if a property or shares in a property investment company are given to another person. Individuals will pay capital gains tax at varying rates; companies will pay corporation tax at the standard rate which is currently 20%.
Individuals do not pay tax on the first £11,100 of capital gains each year (being an annual tax -free allowance) whereas companies may use “indexation allowance” to increase the property’s cost by the rate of inflation which serves to reduce the taxable profits.
Since rental businesses are not trades, individuals cannot use reliefs such as entrepreneurs’ relief or rollover relief.
Access to capital
If a person sells a property, the proceeds may be used as s/he sees fit. However, if a company sells a property and the proceeds are drawn from the company, these proceeds are in effect income to the individual and could result in a significant tax bill.
There is a considerable amount of law governing how companies should be run and how their accounts must be drawn up. This increases the time burden on landlords to meet the administrative requirements and increases accountancy fees as a professional accountant will be needed to ensure the accounts comply with all relevant laws.
It is evident from the above there is no clear winner when it comes to choosing to operate your rental business personally or via a company. The right decision is entirely dependent on your personal circumstances. With this in mind, and along with the ever-changing nature of tax law, you should seek professional advice before relying on any of the information on this blog.