With the recent changes to rules around mortgage restriction relief we often get asked if it is worth incorporating a rental property business or setting up a limited company for letting properties.
As with most tax queries there is no black and white answer and each person’s individual circumstances will determine the planning and structures put in place. Below is a list of some general pros and cons of transferring rental properties into a business, provided by Stuart Clark of Russell & Russell accountants.
- Corporation tax rate (currently 19% and set to reduce to 17%) is lower than income tax rates (20% or 40%).
- Tax relief on mortgage interest for companies but restricted for individuals (more on this can be read in this blog)
- More flexibility regarding the extraction of profits and tax free dividend allowances. The tax on the gain of a sale may be less through a company than personally. There may also be additional mortgage interest relief available to the company and the tax rate is lower. You should therefore have more profits to distribute to yourself, however this will then incur a personal tax charge. With rental income you pay tax on your income in the year, whereas with company income it is only taxable when distributed to yourself. You can therefore only pay small amounts out as and when they are needed or build up a nest egg for later life / retirement and draw down the profits when you need them at a more tax efficient rate.
- No capital gains tax annual exemption and potential loss of Principal Private Residence relief if you previously lived in a property that you are letting. i.e. if you sell any properties personally then the first £11,700 of gains (in the tax year) are free from capital gains tax, whereas a company will pay corporation tax on the entire gain. It therefore depends on the expected gains on each property as if you expect to exceed the £11,700 then it may be better off in a company. Let’s assume you are a higher rate tax payer (ie any capital gains are taxed at 28%) and you sell a property with a £50,000 gain. After deducting your annual exemption of £11,700 the taxable gain is £38,300. With a tax rate of 28% the capital gains tax liability is £10,724. If you sold the same property through a company with a gain of £50,000, there is no annual exemption therefore the entire gain is taxable at 19% = £9,500 – a potential saving of £1,224 (however you still need to extract the funds from the company – see below). There are different rules for capital gains if you are a non-resident landlord (see this other blog on non-resident landlords).
- Potential LBTT on sale / transfer of the property to the company. In order to get the properties into the company in the first instance you need to transfer them from your personal name to the company. This is effectively a disposal of the property and there may be capital gains tax and LBTT to pay on this sale.
- Additional costs to transfer the mortgage in to the company name. In addition to the LBTT noted above as you are transferring the title deeds to the company the mortgage, and other relevant documents, will also need to be updated. There may therefore be legal and administrative costs to consider.
- Early repayment charges on the existing mortgages? If your plan is to use this additional income / tax savings to repay the mortgage quicker then be aware that your mortgage provider may have early repayment charges in place.
- Potentially increased compliance costs although these should be offset by the tax savings (otherwise why would you bother incorporating!). If you are incorporated then you will need to prepare a set of financial statements which get submitted to Companies House and a corporation tax return that gets submitted to HMRC. There will be additional costs to prepare and submit these documents, as well as the other ad hoc / admin issues associated with running a company. These will need to be factored in when considering your long term goals and potential tax savings. It should be noted that a lot of landlords will have increased compliance costs going forward with the introduction of Making Tax Digital (see previous blog).
The best option will vary depending on each person’s own circumstances and their own plans including; How many properties they plan to purchase / let out, what their long term goal is, how long they will hold their properties, Whether any mortgages are interest only or capital and repayment and whether they expect the properties to increase in value. For tailored advice specific to your circumstances it’s well worth speaking to an accountant. Russell & Russell are a firm of proactive accountants who utilise the latest technology to assist their clients to take home more of what they earn and to understand their numbers. If you would like to find out more about their services contact Stuart Clark on 0141 332 6331.