Tax guide on buying investment property through a limited company
Tax guide on buying investment property through a limited company
Despite ongoing and persistent tax and regulation reforms to the UK rental property market, that is reducing the lucrativeness of buy-to-let investments for landlords, the number of rental properties is nevertheless increasing year on year and has been doing so for over 10 years. In 2022, the rental market accounted for over 34% of the UK property market. To maximise rental profits, we have produced a tax guide on buying investment property through a limited company. Continue to read to find out how this strategy can help you retain more of your profits compared to owning buy-to-let properties personally.
What is a buy-to-let?
Buy-to-let is a term that refers to a property investment strategy where an individual or company purchases property with the primary intention of leasing it out to tenants in order to generate rental income. Although buy-to-let is a term that can apply to both commercial and residential property, for the purpose of this tax guide we will be focusing solely on residential property only. Buy-to-let are also often referred to as investment properties.
Buy-to-let properties are different from residential property that you buy to live in as your main residence. This is because, where they are purchased with a mortgage, the rules of most mortgages will prevent you from living in the property yourself. They are also different to furnished-holiday-lets which will allow you to both live in the property as well as rent it out.
Can I buy property through a limited company?
Yes, it is possible to buy property through a limited company. A limited company is its own legal entity and therefore has the ability to own assets including property. What’s more when you buy property through a limited company you will have the protection of limited liability. This means that ordinary loss or legal issues that occur from the property are claimed against the company as opposed to you personally. However, limited liability does not provide protection where you have acted negligently or wrongfully in the course of carrying out company duties.
Why do people choose to buy property through a limited company?
One of the most prominent reasons that triggered an influx in landlords choosing to buy property through a limited company was the introduction of Section 24. Section 24 is legislation which prevents landlords from claiming the cost of mortgage interest as an expense that reduces rental profits and therefore income tax. It was first implemented in 2017 and phased in to gradually increase until April 2020 where mortgage interest tax relief was completely replaced with a 20% tax credit instead. Section 24 only applies to private landlords with properties held as an individual – it does not however, apply to limited companies. Therefore, buying property through a limited company became a popular loophole. Nevertheless, there are other reasons why people may choose to buy property through a limited company such as:
- Investing in property as a business. Some landlords may own one or two investment properties personally as an additional stream of income from their main job. Others, however, may be solely reliant on property as their main business and sole source of earnings. Buying property through a limited company can therefore be a strategic business decision.
- Access to limited liability. As mentioned above, owning property through a limited company offers limited liability. This is beneficial to landlords who want to protect their own personal finances from the financial risks of managing investment properties.
- Receive increased tax benefits. Limited companies have more opportunities when it comes to utilising various tax strategies than individuals. From extracting rental income at a lower dividend tax rate to tax savings when disposing of properties using a lower corporation tax rate as opposed to capital gains tax rate, companies can maximise on rental income by reducing tax liabilities.
- Easily and flexibly divide ownership through shares. When buying a house as individuals, the maximum number who can share ownership in the property is four. However, by purchasing the property through a limited company, you can have as many shareholders as you like. This can be particularly useful for family businesses or if you’re seeking investors.
What are the tax advantages of buying property through a limited company over buying as an individual?
Although buying property through a limited company may not benefit all landlords, for many, the tax advantages mean significant savings when compared to buying investment property as an individual. The tax advantages of buying property through a limited company include:
- Being able to claim mortgage interest payments as an allowable expense. As mentioned above, Section 24 does not apply to limited companies. Most landlords who use a mortgage to purchase buy-to-let properties will be repaying interest only. For limited companies, 100% of this cost is treated as a business expense and therefore reduces profits before corporation tax is applied. For individuals however, interest payments are not a tax-deductible expense and instead only 20% of the mortgage interest payments can be claimed as tax credits.
- Paying lower rates of taxation when keeping profits within the company. Individuals are subject to income tax on profits received from rental income, however limited companies are instead subject to corporation tax. Whilst it may not make much difference to landlords on the basic rate income tax band (20%) compared to limited companies which qualify for Small Profits Rate (19%), there is nevertheless a tax saving. However, when comparing landlords on higher rate income tax band (40%) and additional rate income tax band (45%) there becomes a far greater reason to consider using a limited company to purchase rental property. This is because the main corporation tax rate for companies with profits of £250,000 and more is 25%. Companies with profits of between £50,001 and £249,999 can apply Marginal Relief which further reduces their rate of corporation tax. If you’re not planning to extract rental income from the company for personal use, and instead are planning to re-invest in future properties, buying property through a limited company is much more tax efficient.
- Having flexibility on how to extract rental profits from your limited company. On the other hand, if you are intending to extract rental profits from your limited company for your own personal use, then you will have several options on how to do this. Individuals have no such options as they will simply be taxed on the rental income as income tax. When extracting funds from a limited company however, you’ll have the option to draw either a salary or dividend. Both have their advantages and drawbacks, but a combination of both will usually mean the more tax-efficient outcome. Taking a salary will help reduce your corporation tax and will utilise your personal allowance but will attract NI contributions. Paying dividends offers lower rates of taxation compared to income tax and has its own separate annual dividend allowance for you to utilise; but can only be withdrawn from a company if the company has sufficient funds to do so after corporation tax has been accounted for. The dividend tax rates are 8.75%, 33.75%, and 39.35% for basic rate, higher rate, and additional rate income taxpayers respectively offering a tax saving of between 5.65% – 11.25%.
- Paying less tax when disposing of property. When individuals sell their investment property, they’ll be subject to capital gains tax which is charged at 18% for basic rate income taxpayers and 28% for higher and additional rate income taxpayers. In comparison, companies do not pay capital gains tax, as disposals and transactions such as these are seen as business activities and therefore subject to corporation tax (charged at a maximum of 25%).
- Utilise Business Property Relief when leaving property as part of an inheritance. There are very few legitimate ways you can shield buy-to-let properties from inheritance tax which is charged at 40% as an individual. For limited companies however, some may qualify for Business Property Relief where they can show that at least 50% of the company’s activities involves more than just holding property for investment. This could include buying land or property to develop them before renting and/or selling. If eligible, it means that, by claiming Business Property Relief, you are able to reduce the value of the land and properties owned by the company by 50% before calculating inheritance tax.
What are the disadvantages of buying property through a limited company?
Whilst the tax savings may be attractive, before buying property through a limited company, it’s important to consider the drawbacks as well. The disadvantages to buying property through a limited company compared to buying as an individual include:
- A significant increase to your legal obligations. When you buy property as an individual, you only have to declare your rental income (as well as any other untaxed income) and pay your tax due once a year through a self-assessment tax return. When you’re a director of a limited company, you’ll have to complete your own personal self-assessment tax return for any salary and dividends you receive from the company, as well as complete a corporation tax return, annual accounts, company secretarial, and regular PAYE submissions. In comparison, it is clear that there is significantly more work to be done when you run a limited company. You do not have to do this yourself though if you choose to hire an accountant and their fees are tax-deductible from corporation tax.
- Less mortgage options on the market. If you’re looking to buy investment property with a mortgage, then you’ll likely find that better rates are offered to individuals as opposed to limited companies. There are certainly plenty of lenders who will offer a mortgage to limited companies but it may require finding a mortgage broker to help you ensure that you’ve got the best deal.
- Suffer from double taxation if you withdraw funds from the company. Most landlords buy investment property to receive a return. If you buy property as an individual, all the profits after tax are yours to do with as you choose. When you buy property through a limited company you must extract those profits first before you can do what you like with them, as money within a company must be used for business purposes only. However, when you take money out of a company, either through salary or dividends, it essentially means you’ll need to pay both corporation tax and income tax on the profit earned.
- Prevented from utilising the annual capital gains tax exemption allowance. If you sell a buy-to-let property as an individual, you’ll be liable for capital gains tax if the sale earns you a profit from when you bought the property. However, you can reduce your capital gains tax bill by utilising your annual allowance which is £6,000 for the tax year 2023/24. Limited companies do not receive an annual capital gains tax allowance as they are liable for corporation tax instead on any profits made from the sale of property.
- Very little benefit for basic rate income taxpayers. There are very few tax advantages to buying property as a limited company if you are a basic rate income taxpayer and will remain so even with rental income. We would ordinarily advise that it is not worth doing unless you have long term plans to buy future investment properties or intend to start a property development business.
An example of how you’ll be taxed when buying property as an individual vs limited company
To illustrate whether it is more profitable to buy investment property as an individual or limited company we have provided two comparisons on both ends of the tax scale for a basic rate income taxpayer vs Small Profits Rate paying limited company and an additional rate income taxpayer vs main corporation rate paying limited company.
A basic rate income taxpayer receives rental income of £50,000 (they have no other streams of income) and pays £20,000 in mortgage interest. They would be eligible to receive 20% of the mortgage interest amount as tax relief which is £4,000. A total of £37,430 is subject to 20% income tax (taking into account the personal allowance of £12,570) which is then reduced by the tax relief to £3,486. A total of £3,486 is paid in tax and the individual’s net rental profits is £26,514.
A limited company that qualifies for Small Profits Rate corporation tax with rental profits of £50,000 also pays £20,000 in mortgage interest. The company is able to claim the entire £20,000 as a business expense which reduces the profits down to £30,000. Additionally, the limited company can issue a director’s salary of £12,570 (the personal allowance) which further reduces to the profits down to £17,430. 19% corporation tax is then calculated on that which is £3,311.70. Once corporation tax has been paid, it leaves £14,118.30 in company profits which is available to be withdrawn as dividends. £1,147.85 is due for income tax (accounting for the £1,000 dividend allowance and then dividends charged at 8.75%). The total amount of taxes paid by the company and the director is £4,459.55 and the director receives net rental profits of £25,540.45.
The above calculations show that owning property as an individual is only marginally more profitable than a limited company. However, from the below, you will see that once the rental income increases, it becomes significantly more profitable to own property through a limited company:
An additional rate income taxpayer receives rental income of £250,000 (they have no other streams of income) and pays £100,000 in mortgage interest. They would be eligible to receive 20% of the mortgage interest amount as tax relief which is £20,000. A total of £97,460 is subject to income tax (accounting for tax across the basic 20% rate, higher 40% rate, additional 45% rate, and exclusion of the personal allowance) which is then reduced down by the tax relief to £77,460. A total of £77,460 is paid in tax and the individual’s net rental profits is £72,540.
A limited company that pays the main corporation tax rate of 25% with rental profits of £250,000 also pays £100,000 in mortgage interest. The company is able to claim the entire £100,000 as a business expense which reduces the profits down to £150,000. Additionally, the limited company can issue a director’s salary of £12,570 which reduces the profits further down to £137,430. 25% corporation tax is then calculated on that which is £34,357.50. Once corporation tax has been paid, it leaves £103,072.50 in company profits which is available to be withdrawn as dividends. £28,416.97 is due for income tax (accounting for the £1,000 dividend allowance and then dividends charged at 8.75% up to the basic rate threshold and 33.75% for the higher rate tax threshold). The total amount of taxes paid by the company and the director is £64,338.72 and the director receives net rental profits of £85,661.28.
It is important to note that these calculations do not take into account NI or pension contributions which will reduce the tax further. Also, these calculations are only accurate for the 2023/24 tax year as the dividend allowance is due to reduce to £500 from April 2024.
Should I transfer the property I own to a newly formed limited company?
If you already own buy-to-let properties as an individual and you’re now considering growing your portfolio, you may be tempted to form a new limited company and then transfer your properties to the company. This should be given careful consideration before doing so as it will attract high amounts of taxes and fees so you need to be sure it will be worthwhile for your long-term plans. We often advise that you should not transfer properties to a newly formed limited company because:
- You’ll need to pay capital gains tax. Remember, even if you are not selling an asset, any disposal (including a gift or transfer of ownership unless to a spouse or civil partner) where the asset increases in value is subject to capital gains tax. This is charged at a rate of 18% for basic rate income taxpayers and 28% for higher and additional rate income taxpayers.
- The company will attract Stamp Duty Land Tax (SDLT). This is because the company has acquired property and even where no money has been exchanged, SDLT will be charged on the property’s value. Furthermore, the company will suffer the 3% additional surcharge on residential properties.
- You’ll have to pay for conveyancing and legal fees again. You would have needed to pay for these when you first purchased the property as an individual. To ensure the transfer of deeds is accurately completed into the name of the company, you’ll have to pay for these fees once again.
- May be required to pay early redemption charges on your buy-to-let mortgage. If your investment property has been purchased with a buy-to-let mortgage, then you’ll have to repay it in full before transferring it over to the company’s mortgage provider. If you are within your early repayment period, then there’ll be redemption charges to pay for. It would make most sense to wait, where possible, for this period to end before making a transfer.
Get help with setting up a company to buy investment property
If you have long term plans to build an investment property business, then it can make much more sense to do so through a limited company. Discuss your intentions and plans with us so that we can devise the most tax-efficient strategy in helping you achieve your goals. We can provide a line by line quote to include everything from company formation, corporation tax return submission, annual accounts, self-assessment tax return, and more. Or you can pick and choose from our range of services and just get the help that you need. Get in touch through our online contact form.