The biggest trend taking place in the property market is the huge and sudden shift to people buying properties using private limited companies.
Up until 2015, most property purchased was through family partnerships and sole traders but since then almost 70% of new transactions are done via limited companies. Every specialist UK lender is seeing this change.
The reason for this major ownership reorganisation has been the changes to the treatment of mortgage interest FIRST introduced in the summer 2015 budget – which made the company route far more appealing. It won’t be for everyone, but it is something that every investor should consider now.
Getting the ownership structure right could make a huge difference to the amount of tax you pay over your lifetime (and beyond) – so let’s take a look at the pros and cons…
(Before you start, we need you to know understand this presentation does not constitute tax advice. We are just sharing general information. You should take professional advice from a qualified tax accountant if you are considering buying (more) property.
Are you a trader or an investor?
The first important distinction to draw when making this decision is whether you’re a property trader or investor.
If you buy a property to make value-adding improvements and sell on for a profit, you’re a trader. In this case you’re likely to be best off buying as a limited company.
Why? Because when trading properties as a limited company you will pay corporation tax on your profits – currently 20%. If you’d bought a property to “flip” as an individual, your gains would be taxed as income – which if you’re a higher-rate taxpayer, would be 40%.
(As an individual you might be able to get the profit treated as a Capital Gain rather than income if you could prove that you intended to rent the property out, and maybe did for a short time before selling it, but let’s park that one for now.)
If you buy a property to collect the rent and watch its value creep up over the years, you’re an investor. This is where we get into “it depends” territory: most investors have historically operated as sole traders, but many will now benefit from using a limited company.
Why might investors want to use a limited company?
From a purely financial perspective, there are three obvious reasons why you might want to hold property as a company rather than yourself.
- Tax treatment of profits
If you own a property in your own name, the profits you make from renting it out will be added to your other earnings (such as from your job) and taxed as income tax. But if instead you hold it within a company, the profits will be liable for Corporation Tax instead.
The rate of Corporation Tax is currently 20% (if your profits are below £300,000) If you are paying Income tax at the rate of 40% now, your tax liability will be is halved if you operate through a limited company.
You will still be taxed on the dividends if you take profits out of the company (which we’ll come to later), but there’s flexibility: you can time your dividend pay-outs for maximum tax-efficiency, or distribute them to family members who are only basic rate taxpayers – or just leave the profits rolling up within the company to buy the next property.
- Tax treatment of mortgage interest
As of April 2020, mortgage interest will no longer be an allowable expense for individual property investors (they’ll claim a basic rate allowance instead) – but it will continue to be allowable for companies that hold property. This change is being phased in from April 2017. You should do some personal research on these changes but the upshot is that if you pay tax at the higher rate and you use mortgages to buy property, your tax bill will be higher if you own property in your own name rather than in a company.
- Opportunities to mitigate inheritance tax
Property held within a company gives more options when it comes to planning for Inheritance Tax. It’s a complex field and I don’t propose to go into it here. This is definitely an area you will want to discuss with your financial adviser/accountant. As a rule of thumb, limited companies give you access to specialist trust structures, different types of share classes and a welter of clever legal methods that you wouldn’t otherwise have access to.
So if there’s an income tax advantage, a mortgage treatment advantage and potentially an Inheritance Tax advantage, why wouldn’t you invest through a limited company?
Because of course, there are downsides too…
Points to note when investing in property through an SPV?
- Mortgage availability
This used to be a major drawback: mortgages for companies were limited, expensive and had lower borrowing limits. The number of products on offer for limited companies is still much lower than for individuals, but it’s changing rapidly: as ever more investors are moving in this direction, lenders are following in order to win their business.
You may need to give a personal guarantee and your own finances will be scrutinised, so in many ways it’s a personal mortgage in all but name. So while you won’t find quite as many options and the rates and fees are likely to be higher, it’s less of a deal breaker than before.
- Dividend taxation when you take the money out
If you intend leaving your rental profits in the company to roll up or use them to pay down property loans, pay your corporation tax bill or use it to buy more property – there will be no issue. However, if you intend to take the money out of the business for your own purposes, you’ll be taxed on the dividends you receive. In essence you will be paying 20% corporation tax up to the threshold and then 32.5% above this level on the remainder of what is drawn out of the company.
So if your property investments are a source of income for you there are many things to consider. Going the Limited Company route will save tax in some ways and cost you more in others, then there are the additional costs associated with running your property business this way. The trick is to understand the point at which it is better for you to incorporate. Once again, this is best done with your accountant’s help to work out which will work out best in your situation.
- Extra cost and hassle
This is not a major problem but you should be aware that there are higher accountancy costs associated with filing annual company accounts – so that’s an expense to factor in and you will have more paperwork to deal with.
How to decide if using a limited company is right for you
Whether you go the SPV Ltd Co. route or the sole trader/partnership route will largely depend on these three factors:
- How much income do you have?
If you’re paying income tax at 40% or higher, and you don’t have a lower-earning spouse whose name the property income could be put into, the lure of paying 20% Corporation Tax rather than 40%+ income tax is going to be strong.
A major benefit of using a company to own property comes if you are actively acquiring new properties on a regular basis. Often the costs of acquisition can result in a paper loss rather than a profit. These losses are able to be offset against profits within a company but will disappear for sole trader and partnerships by 2020.
If you plan well within an SPV, taxable gains, which would normally attract a high level of tax if withdrawn from the business while you are a higher rate taxpayer could be delayed until you retire and your income and tax bands have changed.
- Do you want the property income to live off?
Leaving income rolling up in a company (for future purchases, or just until your non-property income falls) will leave you better off than if you need to take it out to spend.
- Do you buy property using a mortgage?
When the April 2017 changes are fully implemented the ability to claim the entirety of your mortgage interest as operating expenses will be gone for ever. This will be a major reason alone why higher-rate taxpayers will be opting to buy future properties and even move existing properties into SPV’s
Finally – who are you buying properties for?
For most property owners, buying and owning property is primarily to provide them with an investment which will fund their retirement. But for many, passing on the portfolio and its income generation to the next generation is equally as important. If passing your properties on is important to you, holding them within a company (if structured correctly) could result in huge Inheritance Tax savings.
The answer remains…”it depends”
There are a lot of different factors in play when you buy property and you need to realise that compromise is inevitable. You will need to weigh up all the pros and cons before deciding whether incorporation is the right path for you.
Above all – you must speak to your accountant: