Is a buy to let limited company now a more tax efficient option than owning property personally? We go through the main factors to consider when deciding whether the buy to let limited company fits your property portfolio.
The rise of the buy to let limited company
The commonly held view was to always retain personal ownership of assets which are expected to increase in value. The recent tax changes to personally held buy to let properties means this theory is being put to the test.
The main tax changes include the restriction in mortgage tax relief, the lowering of corporation tax rates and the 3% premium on stamp duty for 2nd homes.
It has been reported that 70% of all buy to let applications were made by limited companies in 2017. So why is this now the new norm?
Mortgage tax relief
From April 2017 the amount of mortgage interest allowable as a tax deduction is being restricted for personally held buy to let properties.
Prior to April 2017 any interest paid on a mortgage could be deducted from rental profits like any other business expense. Therefore mortgage interest payments of £10,000 would save tax at £2,000, £4,000 or £4,500 depending on what personal tax rate you paid. (20%, 40% or 45%).
From April 2020 the interest relief has been restricted to the basic tax rate of 20% for all individuals. Therefore mortgage interest payments of £10,000 would save tax at £2,000 for all taxpayers. Obviously basic rate taxpayers are unaffected but a higher rate taxpayer could be significantly worse off.
This new restriction was phased in over 4 years between 2017 and 2020. To see how this works and for information read our blog Mortgage Tax Relief
The buy to let limited company is unaffected by these tax rule changes and therefore is an alternative for higher rate taxpayers with large mortgage repayments.
Buy to let limited company – corporation tax
A buy to let limited company is a separate entity. It pays corporate taxes on its profits.
The current corporation tax rate is at 19%.
Comparing the buy to let limited company tax rates of 19% against the current income tax rates for individuals of 20%, 40% or 45% is another positive for the company option.
However the retained profits belong to the company. To extract the profits from the buy to let limited company to the individual a salary or a dividend must be declared.
Extraction of funds
Declaring either a salary or a dividend will likely incur taxes which will need to be paid personally.
This gives the impression that the income is being taxed twice. Firstly the company pays its taxes, then secondly the individual pays their taxes.
We would not disagree with this statement. However it is important to realise that as the options available increases, so does the tax planning opportunities.
Tip: Saving for retirement – A higher rate taxpayer could retain the money within the company thus avoiding any large personal tax bills now. Then when the individuals main source of income ceases such as at retirement the monies could be withdrawn at lower tax rates. For example a higher rate taxpayer would pay dividend tax at 32.5%. Delaying the dividends until their income reduced and they were basic rate taxpayers would see the dividend tax reduce to just 7.5%.
Stamp duty land tax
From April 2016 a 3% premium on stamp duty land tax for residential property purchases was introduced.
This is payable by individuals buying a 2nd property (i.e Not their home which is known as their principal private residence).
It is also payable by a buy to let limited company on any residential property purchased.
Neither option avoids this additional tax.
N.B The 3% is only charged on property purchases which exceed £40,000. Properties under £40,000 pay 0% stamp duty.
Disposal of a property as a buy to let limited company
A buy to let limited Company does not pay capital gains tax. They only pay corporation tax.
Therefore any profits on the disposal of a property by a limited company would be taxed at the current rate of 19%.
The profits paid by a limited company are the sales proceeds, less the cost price, less indexation allowance.
Indexation allowance is only available to limited companies. This simply increases the cost price to todays prices therefore taking into account inflation.
As an example a property purchased for £100,000 in December 1995 would have indexation allowance of £84,500. The taxable profits on any property sale would therefore be the sale proceeds less £184,500.
Unfortunately the government announced in the Autumn 2017 budget that indexation allowance was to cease. Properties purchased pre-2018 would continue to claim indexation allowance up to 31 December 2017. Any properties purchased after 2018 would not be able to claim any indexation allowance.
Disposal of a property as an individual
Individuals who sell properties (which is not their main home) pay capital gains tax on the proceeds.
Capital gains tax on residential property sales is paid at 18% or 28% depending on the individuals income.
Individuals also have an annual allowance for capital gains tax of £12,300 in the tax year 2020/21.
Disposal of property example 1:
A property is sold giving a gain of £25,000.
A limited company would pay corporation tax of £4,750 (gain of £25,000 at current corporation tax rate of 19%)
A basic rate taxpayer would pay capital gains tax of £2,286 (gain of £25,000 less annual allowance of £12,300, leaves £12,700 at a tax rate of 18%)
A higher rate taxpayer would pay capital gains tax of £3,556 (gain of £25,000 less annual allowance of £12,300, leaves £12,700 at a tax rate of 28%)
Clearly in this example it is best to own the property personally. Both the basic rate taxpayer and the higher rate taxpayer pay less tax on the property gain than the limited company.
NOTE: The calculations above are based on the tax allowances in 2020/21.
Disposal of property example 2:
A property is sold giving a gain of £100,000.
A limited company would pay corporation tax of £19,000 (gain of £100,000 at current corporation tax rate of 19%)
A higher rate taxpayer would pay capital gains tax of £24,556 (gain of £100,000 less annual allowance of £12,300, leaves £87,700 at a tax rate of 28%)
Clearly in this example it is best to own the property as a limited company.
N.B The gain exceeds the basic rate so the basic rate taxpayer calculation is not valid.
NOTE: The calculations above are based on the tax allowances in 2020/21.
Transfer personally owned properties into a limited company
Should you transfer properties which you already own into a buy to let limited Company?
Be very careful about doing this as there are significant tax consequences.
The transfer from personal ownership to a limited company is deemed as a sale. The sale is deemed to have taken place at the properties current market value.
The individual will need to pay capital gains tax on the deemed proceeds. There may also be early repayment charges on any existing mortgages on the properties.
The limited company will need to pay stamp duty plus the 3% premium stamp duty tax. The company may also need to pay finance costs which are typically charged when taking out a new mortgage.
The initial cost of transferring the properties often outweighs the long term tax savings so detailed tax planning is a must. Typically we find that leaving the properties owned personally is more beneficial, with only further property purchases going into a limited company.
Conclusion on buy to let limited company
There is no simple answer as to whether a buy to let limited company is more tax efficient than property owned personally.
Individual ownership is likely to be preferred:
- Basic rate taxpayers
- Not affected by the restriction in mortgage relief
- Owns just a small number of properties
- Only has small gains on disposals
- Needs the rental income for day to day living
The buy to let limited company route is likely to be preferred:
- Higher rate taxpayers
- Individuals significantly affected by the restriction in mortgage relief
- Owns several properties and wants to purchase even more
- Has potentially large gains on each property disposal
- Does not need the rental income for day to day living
The above is just a rough guide as there are are just too many factors to consider.
Tax advice from professionals is a must. As a firm of Chartered Accountants we deal with numerous clients who own properties both personally and through buy to let limited companies. If you would like to discuss your individual circumstances with ourselves please contact us.
DISCLAIMER – Please note that the content contained in this article is for general information only and is not a substitute for professional advice – read our full disclaimer