Do you own property that you rent out, either as an investment or as a trade? Then you should look at incorporating as a limited company, as this can save you money!
Recent changes in legislation have eaten into the bottom line profitability of renting out properties. The changes include additional SDLT, restriction of tax relief on mortgage or loan interest, and the replacement of the old wear and tear allowance with a more restrictive relief on the replacement of domestic items in rental properties. You can read more about these changes in our companion blogs on these topics, all on 'Raising the Bar on Property-Ownership'. Running as a limited company will not solve every issue, but it's certainly worth considering.
Many property owners with just one or two rental properties feel that running as a limited company is not worthwhile. However, let me list the benefits:
- You retain control as director/shareholder.
- You have ongoing access to the income (subject to withdrawals from the company suffering income tax at your personal rate).
- Flexibility of ownership for married or civil partners with property portfolios and for other family members. It is much easier (and cheaper) to deal with transfer of shares than ownership of the actual properties.
- Enables the transfer of a property portfolio into a limited company in a tax efficient manner.
- Takes advantage of statutory reliefs that enable the transfer to a limited company without triggering any Capital Gains Tax ('CGT') charge.
- The loan interest is relievable in full against the income at the Corporation Tax ('CT') rate (within the company).
- Income is charged at CT rate rather than at individual rates 20%/40%/45%.
- The company acquires the properties at the market value (crystallising the increase but no CGT on transfer. Any future sale would reflect only the uplift in value between transfer into limited company and sale.
- Stamp Duty Land Tax (or its Scottish equivalent, Land and Buildings Transaction Tax) should not be payable on transfer (subject to very specific circumstances relating to partnerships).
- In due course Entrepreneurs' Relief is available on sale of shares, irrespective of whether or not you are retiring from the business.
- Protection of your other personal assets as only the company's assets are liable for the company's debts.
There are of course one or two downsides:
- The cost of renegotiating loans with the lender. You may have to provide a personal guarantee initially.
- Cost of legal transfer of properties.
- Initial cost of setting up the limited company.
- Compliance obligations as a limited company (but the cost of this is likely to be minimal).
- Unused rental income losses will be lost when the business is transferred to a limited company.
- Unused interest relief will be lost when the business is transferred to a limited company.
For a partnership, it must be demonstrated, that a legitimate and active partnership is undertaking the act of working at making a profit. If there is no partnership, then the SDLT/LBTT may be reduced, by the multiple dwelling relief.
This is not a simple transfer to undertake and will only work in a tax-efficient manner, if undertaken in the right circumstances. Remember that no course of action should ever be undertaken solely to secure a tax advantage - it has to be commercially viable and work for your personally. If you own a property portfolio or just one or two buy-to-let properties why not ask for a review?
Extracting Value from the Limited Company
Income is taxed within the company under Corporation Tax ('CT') and the money that is surplus to the company's requirements can then be paid out in various ways:
- Directors' remuneration (subject to NIC if above the threshold).
- Dividends - but bear in mind that the former tax credit on dividends has been restricted to basic rate tax only, with the first £5,000 per annum of all an individual's dividend income being tax-free (expected to reduce to £2,000 for tax year 2017/18).
- Other benefits.
You also need to bear in mind that when the company sells a property there will be CGT to pay and also that, if you die, the properties will not benefit from the tax-free uplift in value for CGT which would apply if you still owned then as an individual (but your shares in the company will!).
The structuring of extraction of profits in the most tax-efficient way, as well as succession planning for when you retire can be quite a complex issue and I recommend that you take professional advice from your accountancy and taxation adviser.
Trading or investment?
Your company will be classified by HMRC as either being a trading company or an investment company. If you can demonstrate that a significant element of property management or property development is being undertaken by the company itself then you can seek to be classified as trading. In my experience this is unlikely unless the company owns at least 7 - 10 properties. Otherwise, if the reality is that you let the properties and enjoy the profits, it's likely that you will be classified as an investment company.
The significance is that generally there are more tax-efficient strategies available to a trading company.
Annual Tax on Enveloped Dwellings ('ATED')
There is an annual charge for companies owning properties in the UK valued at £500,000 or more on 1 April 2016. But if the properties are buy-to-let properties and are let on a commercial basis to third parties, then a relief can be claimed to set against the annual rental tax due.
Non-natural persons (companies, partnerships with company members and collective investment schemes are collectively referred to as non-natural persons ('NNPs') owning UK residential property are subject to ATED if the property is valued at more than at £500,000 or more on 1 April 2016.
You’ll need to complete an ATED return if your property:
- is a dwelling
- is in the UK
- was valued at more than:
- £2 million on 1 April 2012, or at acquisition if later, for returns from 2013 to 2014 onwards
- £1 million on 1 April 2012, or at acquisition if later, for returns from 2015 to 2016 onwards
- £500,000 on 1 April 2012, or at acquisition if later, for returns from 2016 to 2017 onwards
- is owned completely or partly by a:
- partnership where one of the partners is a company
- collective investment scheme - for example a unit trust or an open-ended investment vehicle
ATED returns must be submitted on or after 1 April in any chargeable period. There are however reliefs and exemptions from this tax, which may mean you don’t have to pay.
The amount you’ll need to pay is worked out using a banding system based on the value of your property.
Chargeable amounts for 1 April 2017 to 31 March 2018
|Property value||Annual charge|
|More than £500,000 but not more than £1 million||£3,500|
|More than £1 million but not more than £2 million||£7,050|
|More than £2 million but not more than £5 million||£23,550|
|More than £5 million but not more than £10 million||£54,950|
|More than £10 million but not more than £20 million||£110,100|
|More than £20 million||£220,350|
Reliefs you can claim
You may be able to claim relief for your property if it is:
- let to a third party on a commercial basis and isn’t, at any time, occupied (or available for occupation) by anyone connected with the owner
- open to the public for at least 28 days a year
- being developed for resale by a property developer
- owned by a property trader as the stock of the business for the sole purpose of resale
- repossessed by a financial institution as a result of its business of lending money
- being used by a trading business to provide living accommodation to certain qualifying employees
- a farmhouse occupied by a farm worker or a former long-serving farm worker
- owned by a registered provider of social housing
Keeping a Property outside a Trading Company
If you satisfy the criteria for a trading company, you may want to keep the premises from which the business trades in the hands of the business owner personally. This avoids the potential charges to SDLT or LBTT when the premises are transferred into the company but are not part of trading stock.
It may also be helpful if you anticipate a future sale of the business. When a property is sold any gain in value is subject to Corporation Tax ('CT') within the company on the proceeds of sale, and in addition there would be an additional charge on the individual where the proceeds of the sale are released from the company.
Entrepreneurs' Relief is still available on the chargeable gain if the business owner sells the property within three years of the disposal of the company.
If the business premises are held outside the company then it may be more tax-efficient from the owners' point of view for the company to pay the owners a commercial rent, rather than the profits of the company being artificially inflated by not having to pay for business premises. As a result of the changes in taxation of dividends applicable from April 2016 (and further restricted in the March 2017 Budget) extraction of profits from a company via dividends is no longer as tax-efficient.
There is no interest relief restriction on commercial premises and if the property is subject to a mortgage full relief for the interest paid is allowable either through the company or for the owner, if the property is owned personally.
So, in conclusion, the benefits of trading as a limited company tend to outweigh any disadvantages and if you can establish it as a trading company, better still. Why not consult your accountant for a review of how this would work for your property portfolio?