The property tax advice you need to succeed
Setting yourself up for success with the right property tax advice
Like it or not, the amount of tax you pay will affect your final investment profits. As such, getting set up with the right tax structure and getting the right property tax advice is important. Starting out with the wrong tax structure could cost you hundreds or thousands of pounds each year in lost returns. In this post, we’re going to look at the two main options most investors use to set up their property portfolio, what taxes you’ll pay under each, and how you can work out which structure is right for you. If at the end you’re still looking for more, speak to your property tax accountant.
It’s worth saying that tax is a big topic and one where things are constantly evolving. What we’ll cover here is just a starter, and it isn’t a replacement for getting the right property tax advice from a property tax accountant. Hopefully, it will give you a feel for what the right tax structure might be for you. Crucially, it will arm you with enough knowledge to seek out an property tax accountant that can help. The right tax structure will depend on your personal circumstances and on your goals. It’s something that needs careful consideration, so make sure you take the time to get it right.
What taxes will you pay?
Whatever your property strategy, be it buy-to-lets, serviced accommodation, or holiday lets, the two main options available for setting up your property rental business are as a sole trader or as a limited company. Let’s take a look at how these options work and what taxes you’ll pay.
The sole trader
If you set up your business as a sole trader, you’ll buy properties and let them out in your own name. The main taxes you pay will be as follows:
- Income tax – You’ll pay income tax on rental profits – that is, the profit you make after you deduct your running costs from your rental income.
- Capital gains tax – When you sell a property, you’ll be taxed on the gain you make, i.e. the increase in value after allowing for purchase costs.
You (or your estate) could also be liable to pay inheritance tax on the value of your portfolio when you die. However, that’s beyond the scope of this particular discussion.
The income and capital gains tax rates, as well as the different thresholds and allowances, change all the time. So, you should look up the latest rates on the gov.uk website. What you need to know is that the rate you pay depends on whether you’re a higher or a basic rate taxpayer. And, higher rate taxpayers pay more tax on income and capital gains. Also, there’s currently a capital gains tax (CGT) allowance you can offset against any gains that you make when you sell a property. This can help lower lower your tax bill. Again, full details are available on the gov.uk website.
The limited company
If you set your business up as a limited company, your company will buy and let out the properties. The main taxes you’ll pay will be as follows:
- Corporation tax – The company will pay corporation tax on rental profits and on any capital gain you make when you sell a property.
- Income tax – As the owner of the limited company, you’ll pay income tax on any dividends you receive from the company.
The corporation tax rate changes all the time. You can look up the latest rates on the gov.uk website. In recent years, corporation tax rates have been lower than the income tax rate for higher rate taxpayers. For basic rate taxpayers, they’ve been at a similar level. You should also know that there’s no CGT allowance for limited companies. So, companies are taxed on the full gain they make when they sell a property. This is another difference versus owning property in your own name.
When you take money out of a company, i.e. by paying yourself dividends, you pay income tax on those dividends. Again, higher rate taxpayers will pay more tax on dividend income than basic rate taxpayers. However, there is a dividend allowance which allows you to draw some dividends out from the company tax-free. Full details on this are once again available on the gov.uk website.
Stamp duty
When you buy a property, you’ll need to pay stamp duty on the market value of the property. This is true whether you buy the property as an individual or as a limited company. However, it’s worth pointing out that if you don’t already own any property and you buy a property in your own name, e.g. to use as your home, you’ll pay less stamp duty. This is because you’ll avoid the stamp duty surcharge property investors need to pay when they buy investment properties.
Which tax structure is right for you?
At this point, you might be wondering which of these structures is right for you. Although this is a complex decision, here’s a look at some of the main factors you should take into account:
1. The headline tax rate
You should be aiming to pay as little tax as (legally) possible. This means you should pick the structure with the lowest headline rate of tax. The corporation tax rate is currently at 19% versus 40% income tax rate for higher rate taxpayers. So, investing through a limited company will give higher rate taxpayers a lower headline rate. If you’re a basic rate taxpayer, the headline income tax rate is currently 20%, and the comparison is not so clear.
2. Mortgage interest relief
Recent changes to mortgage interest tax relief mean that if you buy property in your own name, you can no longer deduct mortgage interest from your rental income as a cost of doing business. Instead, you get to deduct 20% of your interest cost from your final tax bill. Under this new system, higher rate taxpayers will pay more tax, and some basic rate taxpayers will also be pushed into the 40% tax bracket. None of this applies to limited companies, where interest costs are still tax deductible. Interestingly, the changes don’t apply to short term holiday lets in your own name.
3. Potential for double taxation
If you buy property in your personal name, you only pay tax on your rental profits once. However, if you buy in a limited company, the company pays corporate tax on its profits. Then, you pay income tax on the dividends you take out, so there is a potential for double taxation. If you don’t need the income to live off, you can leave the money in the limited company and reinvest it. Also, any money you inject into the company via a director’s loan to get the company started or to fund property purchases can be taken out without paying tax on the withdrawal.
4. The cost of borrowing
Though interest rates have come down and the landscape is now more competitive, borrowing costs remain higher for limited companies. Right now, the interest rate on a 75% loan-to-value mortgage is around 3.0% to 4.0% p.a. for a limited company. This compares with a rate of 2.5% to 3.5% p.a. if you buy in your own name. This should give you a feel for the approximate difference in costs.
5. Administration costs
When you run a limited company, that comes with extra responsibilities. You’ll need to file a set of accounts each year with Companies House. These accounts will need to be prepared in accordance with UK GAAP. You’ll also need to file a CT600 corporation tax return with HMRC. As such, if you go down the limited company route, you’ll need to pay a property tax accountant to prepare these for you, so there are extra costs. This is definitely an area where you need the right property tax advice, so don’t scrimp on these costs.
Pulling it all together
Any clearer now? Here’s my take on it all. If you’re just starting out in property, if you’re a higher rate taxpayer, and if you plan to reinvest your profits to build a decent sized portfolio, then the limited company route might be right for you. You’ll pay a lower tax rate, and your mortgage interest costs will be fully deductible. Also, you won’t get taxed twice, as you’re leaving the money in the company. The higher running costs won’t be too onerous, if you’re planning to build a larger portfolio of say five to ten properties.
If you’re a basic rate taxpayer, if you only plan to buy one or two properties, and if you need the income to live off, you’ll likely be better off investing in your own name. Your tax rate will be similar under either route. However, the extra admin costs for a limited company will be quite high relative to the profit you’re making. The potential for double taxation also makes the company route less attractive. The fact that borrowing costs are currently cheaper in your own name makes this option more attractive too.
Your circumstances may be a bit more nuanced. If you’re a bit of a mix and match of the above, then it may be less clear cut. As always, you should seek some property tax advice from a property tax accountant, to see what’s best for you.
What if you already own properties?
Transferring properties to a limited company
If you already own properties in your own name, you should think about what to do with these. The same considerations will apply as per the above. However, the decision on whether to keep them in your name or transfer them to a limited company is less straightforward. This is because there are costs attached to the transfer. You need to weigh up how the tax saving on transferring properties compares with the upfront costs of the transfer.
It is possible to transfer properties to a limited company. To do this, you need to sell the properties to the company at their current market value. This means you could be liable to pay capital gains tax. In addition, the company will have to pay stamp duty when it buys the property from you. In short, that means there are extra costs when you transfer the properties. Therefore, you need to weigh up how big the costs could be versus the tax savings you’ll achieve via the transfer. This can be complicated, and it’s one to take advice on. Make sure you take property tax advice if you’re considering it.
Transferring all or part of a property to a spouse
If transferring properties to a limited company doesn’t sound cost effective, there may still be things you can do. For example, you could transfer the ownership of part or all of a property to your spouse. This could be a way to “equalise” your incomes. So, it can offer a tax saving if your spouse is a basic rate taxpayer. Again, you should take some property tax advice from a professional, if you think it might work for you.
Property tax advice books and other useful resources
If you’re looking for some specific property tax advice or for a more detailed discussion on what we’ve covered here, then make sure to speak to a property tax accountant. You might also like to check out the following resources:
- the Tax Cafe book “How to Save Property Tax 2021/22” by Carl Bayley – available at Amazon
- the Tax Cafe book “Using a Property Company to Save Tax 2020/21” by Carl Bayley – available at Amazon
- the Government website at gov.uk for the latest on tax rates and tax reliefs
- the tax sections of the Property Tribes and Property Hub chat forums
Finally, it’s worth pointing out that in this section we’ve mainly covered tax issues relating to property rental businesses. If your property strategy means you’ll also be flipping properties for a profit, you should think about what the right vehicle is for those projects. In general, you’ll need to separate your property rental activities and property flipping activities into two separate business, as they’re treated differently from a tax perspective. Again, if you’re in doubt as to the best structure, make sure you get some property tax advice from a property tax accountant on this.