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Landlords: should you set up as a company to pay less tax?

March 2, 2016

Four in 10 landlords are either seriously considering forming a limited company or looking into the option in the coming months, according to latest research from the National Landlords Association (NLA).

This is to avoid the tax hit that will be phased in from 2017, when mortgage interest is no longer fully deductible for High Rate Taxpayers when calculating their tax bill on their rental income.

If you are part of the 40% seriously considering setting up as a company to pay less tax, here’s our complete guide on becoming incorporated.

Can I set up as a company?

Yes. There’s no reason why you can’t set up as a company, despite it infuriating those who see it as tax avoidance. It is completely legal, and many individuals set up limited companies to manage their business matters.

How will it help avoid the tax hit?  

Mortgage interest incurred by a company is treated an allowable business expense and it’s therefore tax deductible.

Currently, landlords are allowed to claim tax relief on monthly mortgage interest repayments at the top level of tax they pay of 45%. From 2017 however Osborne is phasing out the higher rate tax relief available for individuals, and by 2020/21 only 20% will be able to be claimed, regardless of your level of income.

Worked example

We asked London Accountancy firm, Accounts & Legal for a worked example for a high rate taxpayer, using a £500,000 BTL property with a 4% yield, a 75% loan to value interest only mortgage, and an interest rate of 2%.

On the surface, an individual landlord in 2016 and a company appears to take home the same amount of cash - £7,500.

The difference however, is that income tax on dividends ("Dividend tax") is only paid if the cash is withdrawn from the company. If it is retained in the company and reinvested, the company would be £2,500 better off than the individual landlord in value terms.

By 2021 however, when the individual is no longer receiving tax relief on mortgage interest, the difference in take home cash is stark. As the table and graph show, as a company you’ll pay corporation tax rather than income tax on the profit you're left with after deducting all mortgage interest, which will leave you with substantially more cash after tax. And furthermore, the rate of corporation tax is set to decline by a further 1% to 18% in 2020, widening the gap even more.

What if the interest rate was higher?

The difference between an individual and a company is even more obvious when the interest rate is higher. Take a look at the table to the right, which also shows a property with a 4% yield and a 75% loan to value interest only mortgage; the difference here is that the interest rate is higher at 3%.

This shows that the cost of keeping the property in your own name, rather than incorporating, increases substantially with the mortgage interest rate. It's important therefore to make sure you are on the lowest possible mortgage interest rate.

So why isn’t everyone incorporating?

So far, it sounds like landlords would be mad not to incorporate. But not everyone will benefit - especially not those who are already only paying the basic rate of tax (20%).

“For landlords without another source of income or who are not high rate taxpayers, retaining the rental property personally allows them to utilise their annual tax-free personal allowance and basic rate tax bands, together totalling £42,385 per annum - which may well be more tax efficient.” Chris Conway, Managing Director, Accounts & Legal.

What happens when I come to sell my property?

If you choose to incorporate your portfolio of rental properties into a company, any gain will be subject to corporation tax when you come to sell. The distribution of the post-tax retained profits in the company will then be subject to either income tax or capital gains tax, depending on how the funds are distributed, incurring an effective total rate of tax of between 42% and 44.7% for a high rate taxpayer.

An individual on the other hand will only suffer capital gains tax on disposal of an investment property of up to 28%, so if you plan to sell your investment property in the near future, it’s unlikely that incorporation is going to benefit you.

How much will it cost to incorporate?

You also need to consider the cost of incorporating and ensuring the ongoing compliance of the new company. This includes filing annual accounts and an annual return at Companies House, and filing corporation tax returns with HRMC, which typically costs £500 to £1,000 per annum.

How do I set up a limited company?

Setting up a limited company is relatively straightforward. You’ll need to register on Company House - which will cost you £15 - then you’ll need to register the company with HMRC. The company will then need to buy your buy-to-let property (if you already have one) and pay stamp duty on the property. There is relief available for any capital gain at the date of transfer. It only takes 24 hours for your company to be registered.  

May not the best decision for lower-rate tax payers or those who only have one buy-to-let property

Though incorporating can help guarantee your monthly tax bill, it may not be the best decision if you are a lower-rate tax payer or if you only have one buy-to-let property.

If you’re already a landlord with buy-to-let properties, a better idea may be to cut your interest costs by re-mortgaging and getting an up to date rental valuation on your property.

Your lender will therefore have to recalculate your LTV, and a lower LTV ensures a better interest rate and a larger selection of lenders.

If you’d like any more information on the topics discussed, give us a ring today on 020 7099 4000.

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Iftikhar Rashid
31 May 2017
Hi, Good Evening

Thank you so much for your suggestion and discuss these important points about landlords tax.
The points you are listed above, really appreciable and will really help in landlords tax procedure.

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