London is a leading world-class city with a booming rental market and prime property that benefits from consistent capital growth. Unsurprisingly, central London areas such as Chelsea, Kensington, Knightsbridge and Mayfair are a magnet for property investors.
In recent years, there has been a substantial move towards buying investment property through companies that are listed as limited. This has primarily been driven by changes to the mortgage tax relief rules.
These were introduced by former chancellor of the exchequer George Osborne back in 2015. Aimed at cutting back on the number of private landlords in the UK they were introduced on a sliding scale. It got to the point that, as of April 2020, private landlords could no longer deduct any mortgage expenses from their rental income to reduce their tax bill. This has resulted in landlords seeing a considerable reduction in their after-tax profits, for some central London landlords by as much as 40 per cent.
Some landlords did leave the profession but it didn’t have the intended effect Mr Osborne was looking for. That’s because many individual landlords with a handful of buy to let properties changed their status from paying tax as an individual, to that of a company. In this sense they would be paying corporation tax.
And, because limited companies can treat mortgage interest as a cost and corporation tax and dividend tax rates are much less than the income tax rate for higher-rate taxpayers, it made sense for a vast number of private landlords to go down this route. Even today, many landlords consider setting up a limited company rather than paying tax as an individual property investor.
It that’s you though it’s worth looking carefully at the pros and cons before making that final decision. That’s because, like many things in life, nothing is ever black and white ie there are both advantages and disadvantages to becoming a limited company when investing in buy to let property. To try and help you determine whether buying houses and apartments to rent out via a limited company is tax-efficient for your individual circumstances, we have listed both sides of the argument below:
Advantages of buying through a limited company
Tax treatment of profits
For private landlords, profits from rental income are taxed via income tax alongside their other earnings. That means adding the money made from rental income to the amount you receive from a salary, as well as any other money received from shares or dividends. Income above your personal allowance is taxed at the rates listed below. Currently, the standard personal tax-free allowance is £12,571 (although this reduces if your income is over £100,000).
|Tax Band||Income||Tax Rate|
|Basic Rate||£12,501 to £50,000||20%|
|Higher Rate||£50,001 to £150,000||40%|
|Additional Rate||over £150,000||45%|
If you invest in property via a company with limited status, you will be liable for corporation tax on your profits. The corporation tax rate is currently 19 per cent, but is set to rise to 25 per cent by 2023.
If you are a higher-rate taxpayer you stand to make an enormous tax saving.
You will still be taxed if you want to access your rental income, either via income tax on the salary you pay yourself or tax on dividend payments. More on this later when we look at the tax you’ll pay when you take your money out of your company. However, there are ways a tax accountant can minimise the tax you pay.
Tax treatment of mortgage interest
Private landlords can no longer deduct any of their mortgage expenses from rental income to reduce their tax bill. Instead, they receive a tax-credit, based on 20 per cent of their mortgage interest payments. If you are an additional or higher rate taxpayer you won’t get all the tax back on your mortgage payments as the credit only refunds tax at the basic rate and not the top rate you paid. Furthermore, you may also find yourself pushed into the next tax bracket because you will need to declare the income that was used to pay the mortgage on your tax return. This has been a common problem for many property investors and is it why it made more sense to become a limited company, rather than pay tax in a higher band.
Limited company status becomes much more attractive because, unlike property owned by an individual investor, mortgage interest is treated as a business expense for limited companies. This means it’s possible to deduct the cost of mortgage interest before paying your corporation tax.
Inheritance tax benefits
Landlords planning to pass their property portfolio down to children or family members could avoid large amounts of inheritance tax by buying the property through a limited company. That’s because they can apply Business Property Relief (BPR) to their income and assets. Since 2013 property investors have been allowed to hold shares which qualify for Business Property Relief in a tax-efficient ISA account. Public companies can’t access this BPR because their shares are listed on the stock exchange. At the same time, sole traders (ie self-employed property investors) are forbidden from accessing it if they plan on transferring fixed assets, such as premiss, land and machinery. In other words, this is a form of tax relief specifically aimed at limited companies.
Disadvantages of buying through a limited company
The number of buy-to-let mortgage products on offer for limited companies is much lower than for individuals. Because of this, you may find it much more difficult to arrange a mortgage. On top of that, the interest rates will probably be higher too.
Tax when you take money out
To access your rental income, you can pay yourself a salary. This will be liable to income tax but will count as a cost when calculating your pre-tax profit for corporation tax purposes.
Rental profits taken as dividends are not considered a business expense. For tax year 2022-2023, the tax-free allowance on dividends is £2,000. How much tax you pay on dividends above this amount depends on your tax band. The following dividend rates apply.
|Tax Band||Tax rate on dividends above the allowance|
If you plan to leave the rental profits in the company, this is not a problem. However, if you need to live off your rental income (which many small-scale landlords do), then you will need to do the maths to work out whether a limited company reduces your tax bill. Speak to a tax accountant as there are ways you can maximise your tax-efficiency, such as splitting dividends with a spouse who is a basic rate taxpayer.
Transferring any properties you own in your own name is costly
In order to switch your company over to one with a limited status, you have to go through a prescribed legal process. This involves paying taxes and conveyancer fees. Effectively, you have to ‘sell’ your properties to yourself. Naturally, there are costs involved in this, such as:
- Capital Gains Tax – Any profit you make on your bricks and mortar investment will accrue tax. The amount of CGT you will pay is dependent on how much income tax you pay on an annual basis. That means if you’re a basic tax payer you’ll pay 18 per cent CGT, whereas the higher tax rate is calculated at 28 per cent.
- Stamp Duty Land Tax – Usually referred to as SDLT, this is a standard charge based on your property’s worth. But in addition, because the investment property isn’t your main residence, you will also be due to pay a further three per cent tax. That’s because it comes under the ‘second home’ category.
- Conveyancing and solicitor fees – Just as if you were selling to another individual, the standard procedure will apply ie a solicitor or conveyancer will be required to ensure the switch is legal.
- Early redemption charges and increased mortgage costs – Some lenders will charge a repayment fee if you have only just started paying your mortgage off. This is typically between one per cent and five per cent.
For some landlords, these costs make moving to a limited company very prohibitive. For others, the long-term tax savings far out-weigh these costs.
Extra cost and hassle
Limited companies have to file annual accounts, so you will need to pay an accountant. Running a limited company also requires more administration and paperwork.
Frequently asked questions about buy-to-let through a limited company
1. What does setting up a limited company involve?
You will need to choose a company name and register your company with Companies House.
To do this, you will need to :
- appoint at least one director
- decide who the shareholders are and issue shares
- prepare a Memorandum of Association and Articles of Association to agree on how you will run your company
It costs £12 to register a new company. You will receive a certificate of incorporation. This confirms the company legally exists and shows the company number and date of formation. It is a fast process, with the result that you will usually be established as a limited company within 24 hours of application.
The gov.uk website has more information about setting up a limited company.
2. Will my company be able to borrow money?
Yes, but as we mentioned earlier in this article, you may find the interest rates are higher than personal mortgages, as lenders perceive the risk to be higher.
Expect the loan to value percentage to be lower too, many lenders ask for 70 per cent for repayment mortgages and 65 per cent for interest only. This means that you will need an even bigger deposit than you have paid in the past for a standard buy to let mortgage (usually around 40 per cent).
Banks are often more wary of lending to companies as they have limited liability, in order for your limited company to get a loan you will probably need to be prepared to provide a personal guarantee.
3. I’m buying my first buy-to-let property, should I do this through a limited company?
This depends on your future plans as a property investor. If you are only ever planning to rent out one or two properties at most, setting up a limited company is probably not the best route to go down. However, if this is the beginning of a budding property empire you plan on establishing, then it may indeed be cheaper and easier to create a limited company from day one.
4. If you own property in your own name, is it worth transferring it to a company?
This will depend on how many properties you have. If, for example, you only have a couple of buy to lets then it probably won’t be worth switching. If your portfolio is a large one though it’s definitely worth looking into. Find a good tax accountant, especially one who specialises in property, and they should be able to advise you on what to do next.
You will need to calculate all the costs, as outlined above, and weigh this up against the tax savings you could make.
Find out more
If you own or are thinking of buying an investment property in Belgravia, Knightsbridge, Chelsea, Mayfair, South Kensington, Victoria or Westminster, either as an individual or through a limited company, Best Gapp can help. Contact us today to find out more.