Buy-to-let property has long since been a lucrative investment, however, from last year, we’ve been seeing a strong trend in people shifting how they manage their portfolio. This is because, since 2017, the Government began phasing in cuts to tax relief for interest on buy-to-let mortgages.
Tax due on rental income is calculated on the amount after allowable expenses have been deducted, such as cost for repairs, letting agent fees, landlord’s insurance etc. Previously, allowable expenses also included the interest on the buy-to-let mortgage. From 2017, only 75% of the interest will be an allowable expense, reducing down to 50% in 2018, 25% in 2019, and from 2020, mortgage interest will no longer be an allowable expense. Instead, a tax credit of 20% of the mortgage interest can be taken against your overall tax liability for the year. For those who are on the upper limit of the lower rate tax band, it could potentially mean being pushed up into the higher tax rate threshold of 40% income tax. Indeed, the same can affect those on higher rate tax bands getting pushed up to the additional rate tax band of 45%.
In response to the new tax changes, there has been an increase in rental property ownership being taken out by limited companies as opposed to private individuals. By doing this, rental profit is subject to corporation tax (19%) and not to income tax. Although only a marginal difference for those on the basic rate, it’s a significant saving for those on the higher rate or additional rate. It is also worth noting that corporation tax is set to decrease to 17% by 2020.
So, is it really worthwhile switching your rental property over to a limited company? Our advice is that there is much more to take into consideration.
- Getting a buy-to-let mortgage. When it comes to looking for buy-to-let mortgages you will find that the more favourable rates are only available to those looking to personally borrow funds. Companies will often face a limited choice in lenders, higher fees, and a more complicated borrowing process.
- Transferring property over to a limited company. If you already own rental property as a private individual and are planning to transfer this across to a limited company, then you really need to take a moment to do the maths beforehand to ensure it will be worthwhile. By transferring property, you will trigger the usual tax implications. You face incurring capital gains tax (CGT). Basic rate taxpayers are charged at a rate of 18% and higher rate and additional rate taxpayers are charged 28% for residential property. In addition you will also have to pay stamp duty (at the additional rates), potentially ATED (annual tax on enveloped dwellings), and legal costs.
- Creating a limited company to buy a new rental property. One way to avoid paying CGT on the transfer of a property is to buy the rental property as the limited company in the first place. If you do not already have a company, then setting up a new company for the purpose of managing rental property is a relatively simple and inexpensive procedure. Nevertheless, you should bear in mind that a company has ongoing running costs, legal obligations and a fair amount of administrative responsibilities. You will be required to complete a company tax return, annual statutory accounts, and complete your company secretarial duties. Depending on the size of your property portfolio, you may also need to file VAT returns. If you need help in completing these, then you will need to factor in the additional cost of an accountant’s fees.
- Extracting money from a limited company. Once rental income is being paid into the company, you may wish to draw out the funds for personal expenses. You’ll be able to do this by paying out dividends. As of April 2018, the tax-free allowance on dividends has been cut down to £2,000 from £5,000. However, the tax rate on dividends is still lower than the income tax rate, which is just another reason why owning property as a limited company is growing in popularity. As a basic rate taxpayer you would be charged a rate of 7.5% on dividend payouts, 32.5% for higher rate taxpayers and 38.1% as an additional rate taxpayer.
- Tax is continually changing. The one thing we can say for certain is that the Government is always looking for new and different ways to charge tax. With Brexit as a significant uncertainty, there is no doubt that there will be further changes to come. Taking a look at the rental market itself, there is a decline in applications for buy-to-let mortgages in general. This is likely to be as a response to the cuts in tax relief, as well as the growing obligations imposed on landlords to maintain an acceptable standard of living for their tenants.
What else should you know about buy-to-let? If you’re looking for more tax advice to find out if your potential investment is as profitable as you would like, the best advice will come from tax experts – chartered accountants. Other aspects we’ll take into consideration will be each individual’s circumstances; such as whether or not you have a spouse or partner, what their income is, and whether or not you can use their tax allowance. We’ll also give you the best advice for short term and long term plans, such as whether you would look to sell the property in the future or if you would prefer to pass the property onto children as part of your inheritance.