Tax returns are now due for 2017-2018, which means your landlord clients are starting to experience the financial impact of recent tax changes. This could trigger a conversation about whether they should consider holding their investment in a limited company, so what are the considerations?
Counting the cost of the changes
Historically, private landlords have been able to claim back the interest they paid on their buy-to-let mortgages on their Income Tax returns and landlords in the higher 40% and 45% tax brackets could also claim tax relief at this higher rate.
However, this tax relief is being phased out over the next four years and from April 2020 tax relief can only be reclaimed at the basic rate (20%).
On an example where a buy-to-let property worth £150,000 is rented out for £750 a month and owned by a private landlord in the 40% tax bracket, whose mortgage interest payments are £450 per month, this change could halve their annual profit from £2,160 to £1,080.
How does becoming a limited company make a difference?
Limited companies pay Corporation Tax, not Income Tax, and by April 2020 Corporation Tax rates will be just 17%.
Using the same example as above, the tax liability if the same buy-to-let property was owned by a limited company in 2020 would be much less, which could mean a profit of £2,988 – nearly three times as much as owning the property as an individual.
Things to consider
Owning a buy-to-let investment with a limited company may be more tax efficient, but there are a number of considerations:
- Taking an income – When a limited company owns the properties, the limited company also owns the profits – so landlords will probably have to pay income tax on any money they’re paid by their limited company. Limited companies must keep accounts detailing all income and expenditure, and all purchases using company money must have a demonstrable benefit to the business.
- Transferring ownership of the properties – When a landlord registers as a limited company, the company must have legal ownership of the properties in the portfolio. They can’t simply transfer them – they must be sold by the landlord to the company, at the market rate. As such, they may incur several costs in the process – including early repayment fees on any mortgage, Capital Gains Tax, and Stamp Duty.
- Selling a property – Limited companies don’t pay Capital Gains Tax, but any increase in the value of a property is viewed as profit when the property is sold, with Corporation Tax due.
Most individuals liable to pay Capital Gains Tax get an annual allowance, (£11,700 in the 2018/2019 tax year) and only pay on gains above this amount, whereas Corporation Tax is payable on the entire profit. Depending on the level of gain, it could therefore be more expensive to sell a property as a limited company than an individual.
The importance of specialist advice
These considerations demonstrate that every client and every investment is different, and a limited company may not necessarily be the best approach for everyone. It’s important they you understand your client’s individual circumstances and plans, and that you partner with a specialist tax adviser who will be able to talk through their individual position and liabilities.
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