Buy To Lets

Buy to Lets – should I purchase in my own name or through a company?

There have been a lot of changes to the taxation of residential property over the last 5 years, particularly in the buy to let residential property market (“BTL”). Below is a summary of some of the issues to think about when considering how best to structure a purchase of a BTL:

Stamp Duty Land Tax (“SDLT”)

The rate of SDLT will normally be the same for a purchase of a BTL through a limited company as for a purchase personally. The default rate of SDLT for a company is 15% but this usually only applies where a BTL is occupied by a shareholder or director (or a person connected to a shareholder or director) within 3 years of purchase. The normal rates of SDLT will apply where a BTL is purchased by a company and is used for the purposes of a property rental business or for development and resale.

The 3% surcharge always applies to a BTL purchased through a company, but this also applies to an individual purchases of a BTL where the individual owns any other residential property valued at more than £40,000 anywhere in the world; which is almost always the case.

Taxation of rental income profits (“CGT”)

Where a BTL is held by an individual for the purposes of a property rental business as a long-term investment then the annual profits of the business are added to the taxpayer’s other income and taxed at the individual’s marginal rate of income tax i.e. 20% for basic rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate taxpayers.

Where a BTL is held by a company the tax rate on the annual rental profit is currently 19% and due to fall to 17% in 2020.

Where a BTL is acquired with the intention of development and later sale then the gain will be treated as a trading profit in the hands of an individual and taxed at income tax rates of up to 45%, plus 2% national insurance. By contrast the tax rate remains the same in a company at 19%, falling to 17% in 2020.

There is therefore a much lower tax rate for the taxation of profits in the corporate regime compared to ownership personally, and the tax rate is materially lower for development profits.

Interest

Interest payments by a company can be deducted in full from any rental profit or development profit as appropriate. However for an individual there is a restriction on the amount of interest deductible for a residential property rental business. The restriction is being phased in over 4 years and by 2020 tax relief on interest payment will be restricted to the basic rate of income tax. For example, if you are a higher rate 40% taxpayer and your property rental business has £50,000 of rental income and £20,000 of interest paid, then under the old rules you would have a net profit of £30,000 on which your tax liability at 40% would be £12,000. Under the new rules you will be taxed in full on £50,000 (= £20,000 tax @ 40%) and then given a tax credit on the interest paid at the basic rate of tax (so £20,000 x 20% = £4,000). So your tax liability will now be £20,000 – £4,000 = £16,000, a significant increase from the old liability of £12,000.

The lesson here is that if you are expecting to have significant interest payments then purchase through a company is likely to make more sense than a purchase personally.

Capital Gains Tax (“CGT”)

Where a BTL is held for the purposes of a property rental business as a long-term investment then the tax rate applying to the profit on a later disposal is 28% for a sale by an individual (or 18% if the gain falls within the basic rate tax band of the seller when added on to his income), whereas in a company the tax rate is currently 19% and due to fall to 17% in 2020.

Loan repayments

It will usually be more beneficial to purchase through a company if you have third party loans that need to be repaid. The loan repayments can be financed out of profits that have been taxed at 19% in a company whereas the higher personal tax rates mean there is significantly less post-tax income from which to make loan repayments.

Profit Extraction – Income

It is evident from the analysis above that there are a number of advantages of purchasing a BTL through a company, but as expected there is one material disadvantage which is the extraction of profits from the company. The most tax efficient method of extracting profits from a company is by way of dividends, but dividends are now subject to higher tax rates than other types of income. So for example a £100 rental business profit will be taxed at 40% for a higher rate taxpayer, leaving him with £60. In the corporate regime, the £100 profit will be taxed at 19%, leaving £81 and if this is then paid out as a dividend it will be subject to further tax of 32.5% for a higher rate taxpayer, leaving a net £54.70, so the taxpayer is £5.30 worse off.

However, the shareholder is better off if the interest rate restriction applies. Using the example in the paragraph headed “Interest” above,  the personal owner has a net profit of £30,000 on which he pays £16,000 tax leaving him with £14,000 net of tax. In a corporate environment, the taxpayer would have a profit of £30,000 less 19% tax = £24,300 post tax. If this is paid out as a dividend he will pay tax @ 32.5% = £7,897 leaving him with £16,403, so overall he is £2,403 better off in this scenario.

Profit Extraction – Gain

When a BTL property is sold the tax is 28% personally, so on a gain of £100,000 the taxpayer is left with £72,000. In a company, the gain is taxed at 19% leaving £81,000 and if this is then paid out as a dividend the taxpayer has a higher rate liability of 32.5% leaving him with just £54,675 or around £17,000 less than in the personal regime. It is possible to extract capital profits by way of a winding up in which case the tax rate would reduce to 20% from 32.5%, leaving the taxpayer with around £65,000, but this is still a reduction compared to personal ownership. There are also some anti-avoidance issues that need to be considered before proceeding with the capital extraction route.

Annual Tax on Enveloped Dwellings (“ATED”) and Benefits

Apart from the additional SDLT payable where a residential property purchased by a company is occupied by a connected person within 3 years, there are a couple of further tax disadvantages if a property may be subject to occupation by connected parties. There is an annual tax charge known as ATED where a company owns property valued at more than £500,000 which is subject to private use by a person connected to the company. The annual tax charge is based on the value of the property and the charges for 2019/20 are as follows:

Furthermore, any private occupation by a person connected to the company (eg a shareholder, director or their direct relatives) will trigger a benefit in kind charge on the occupier which in broad terms is equal to the difference between the annual market value and the rent actually paid by the occupier to the company.

Inheritance Tax

There is no material inheritance tax difference between ownership of a BTL personally and ownership through a company, although ownership through a company does offer more flexibility in terms of transferring ownership to the next generation in the future.

Conclusion – corporate v private ownership

In summary we usually recommend the corporate route where there will be long-term investment financed through long-term borrowing, or where there will be property development with profits reinvested in a series of projects. Personal ownership is usually preferred if there is likely to be any occupation of the property by connected persons and the residential property is valued at more than £500,000.