If you're looking to invest in property, you are probably wondering what the most tax efficient means of ownership is; do you setup a limited company, or acquire the property personally?
In this article we discuss some of the pros and cons of private vs. corporate ownership.
The tax benefits can vary - and you might also need to consider the implications of Capital Gains Tax ("CGT") upon eventual sale.
Finance charge restrictions
Since 2017, HMRC have been gradually withdrawing the tax relief on mortgage interest deductions, which has been hammering landlords. Prior to 2017, landlords who personally owned property, could deduct 100% of their mortgage interest payments from their property income. Landlords paying tax at the higher or additional rates benefited significantly from this.
The changes implemented in 2017 have resulted in a gradual restriction of higher and additional-rate tax relief. By 2021, even if a landlord pays tax at the higher or additional rates, they will only obtain basic rate (currently 20%) relief on interest costs. A full chronology of the finance charge restriction is shown below:
in 2017 to 2018 the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction
This restriction, however, does not apply to companies (interest deductions are 100% allowable in accordance with the corporation tax rules). This can make it more tax-efficient (as far as net rental income is concerned) to own rental property through a limited company.
Different tax rules
Rental income -
If owning property through a limited liability company, net rental profits will be subject to corporation tax (currently at a rate of 19%) vs. the higher personal income tax rates (currently 20%, 40% & 45% for basic, higher & additional rate taxpayers, respectively).
However... once you have paid tax on your company profits, you will need to extract the residual cash from the limited company. To maximise tax efficiency at this stage, company directors will want to do this by declaring dividends. The current dividend tax rates are: 7.5%, 32.5% & 38.1% for basic, higher & additional rate taxpayers, respectively.
Tax Planning Tip: If you do not need the cash today, you might want to consider keeping rental profits in the limited company for the time-being. You can extract these accumulated profits later on e.g. gradually, during retirement when you will likely pay tax at a lower rate.
Disposal of property & Capital Gains Tax ("CGT") -
You will be personally liable to CGT upon eventual sale of property if the property is owned by yourself as an individual. The current CGT tax rates for personal 'property and carried interest disposals' are 18%, 28% & 28% for basic, higher & additional rate taxpayers, respectively.
As an individual, you will receive an ‘annual exempt amount’ (currently £12,300), which is not available as a relief for limited companies.
However, if selling property through a limited company, the company will pay a lower rate of corporation tax (again, currently 19%) on the chargeable gain. As above, you will then also need to extract this money from the limited company, usually by way of dividend at the applicable dividend tax rates.
Other factors
Annual Tax on Enveloped Dwellings ("ATED") – if the value of the property you are purchasing is more than £500,000, a company will also have to pay the annual tax on enveloped dwellings. The amount depends on the value of the property, although there will be £nil liability arising on property valued below £500,000. Note - the £500,000 threshold is the current threshold for tax year 2020/21.
Stamp Duty Land Tax ("SDLT") – there will be a higher rate of SDLT payable on property costing >£500k, when acquiring via a limited company.
Summary
The above considers a handful of factors that you may wish to consider when choosing how to purchase an investment property.
The above factors will vary in significance, depending on your own personal circumstances - although generally speaking, the benefits of corporate ownership will tend to favour higher and additional rate taxpayers. For basic rate taxpayers - due to the personal tax rate being only 1% higher than the corporate tax rate (for rental income), and actually 1% lower for CGT purposes (for property disposals), the tax benefits of corporate ownership are likely to be less pronounced.
If you are curious about investment property and/or need advice which is tailored to your own personal circumstances, get in touch with the Waite Financial team, at contact@waitefinancial.co.uk.
Please note that the above article does not constitute advice. The above article is intended for information purposes only, and specific advice should be sought through formal engagement.