Meg Saksida considers the pros and cons of incorporating a rental property business.
Landlords who hold their business in a sole trader (ST) structure are very often tempted by incorporation. There can be so many advantages on top of the lower tax rate, and all are a great lure, but incorporation can also have some downsides.
Before incorporation is considered as the panacea to all the woes of the ST landlord, the complete list of cons must also be considered.
Lower tax rates and no interest restriction
Holding the properties inside an ST business will mean income tax rates of between 20% and 45% and capital gains tax (CGT) rates of 18% or 28%. This can be compared with income and gains inside a limited company charged to corporation tax at 19% until at least 2023, and even then, only those companies with profits over £250,000 will pay the higher 25% tax rate.
Furthermore, the interest restrictions for an individual are not in point with a company, so highly geared landlords might prefer the safe haven of having all interest paid on mortgages deducted without having to limit the deduction to the basic income tax rate.
The problem, however, is the cost of extracting these profits. Although dividends of up to £2,000 a tax year can be received at a 0% tax rate, anything above this will be at the landlord’s highest rate and if extracted through a salary, this will be taxable from the first £1, assuming the landlord already has income to cover their personal allowance.
The second issue may be the tax on incorporation. This may be from CGT arising on the disposal of the properties from the individual to the company, which could take years to break even. Although deferring the gain through incorporation relief may be an option, it requires ‘the sort of activities that are indicative of a business’, which HMRC indicates would be substantial and around ‘20 hours a week’; so a simple buy-to-let property business is unlikely to be eligible.
Limited liability
Increasingly, there are more and more onerous obligations on landlords. Keeping the property free from health hazards, ensuring gas and electrical equipment is well installed, regularly maintained and safe, and providing energy performance certificates are now all obligatory. If the landlord is involved in property development, the list is even longer and the risks even greater.
If a tenant were to successfully sue a landlord trading as an ST, the landlord would have unlimited liability for the damages. Limited liability for companies is, therefore, a huge advantage. The shareholder is liable only up to the amount of unpaid share capital in the company. Beyond this, the veil of incorporation should not come down, and the shareholder landlord will not need to fear for any of their personal wealth held outside the company.
Limited liability does, however, come at a cost. If privacy is important, a limited company may not be an option, as shareholder and director information must be made publicly available through Companies House, and all information disclosed must be kept up to date. Furthermore, the company must ensure that it files its annual financial statements in accordance with generally accepted accounting principles (GAAP), and these financial statements also need to be available publicly. The officers of a limited company must also satisfy the requirements of the Companies Act, which includes a myriad of standard processes and procedures that must be followed in order to achieve certain ends.
Finally, there is a potential for personal liability on the directors of a limited company. Under the Insolvency Act 1986, a director who continues trading when they know that the company has no reasonable prospect of avoiding insolvency could be asked by the liquidators to contribute to the company’s assets personally. Although there was a brief suspension in this legislation due to the Coronavirus pandemic, from 1 July 2021 the legislation is back in force.
Other pros and cons of a limited company
(a) Sharing the love
Spreading the income (and associated tax burden) generated from a property business within families is much easier to do through share ownership than by splitting up the ownership of properties.
In addition, planning for inheritance tax on death may be easier with shares in a limited company rather than properties owned directly. This is because shares are fungible assets and, as such, easy to split and leave to several different legatees, whereas it is difficult to break up a property, and there are other limiting rules when there are minors and property to consider.
(b) Pensions
The whole point of pensions is to contribute from your earnings while you are young enough to work, so you can enjoy the fruit from your investment once you are no longer working. Any contributions over £3,600 a year, therefore, need to be made from ‘relevant earnings’.
An ST receiving only rental income (unless it is furnished holiday accommodation rental income) will not have ‘relevant earnings’ for pension purposes. Alternatively, by putting the properties into a company and drawing a salary, the salary earned will be defined as ‘relevant earnings’ and can thus be contributed to the pension pot.
(c) Making tax digital and the 60-day CGT deadline
Individuals selling residential property in the UK now need to declare and pay CGT due within 60 days after the completion date. This is not required for companies who, unless they are large, need to pay their corporation tax nine months and one day after the end of the accounting period.
Making tax digital is also due to come in for individuals’ annual business or property income above £10,000 from their next accounting period starting on or after 6 April 2024 (delayed a year due to the pandemic). The government has promised not to make this mandatory for companies before 2026.
(d) Whose company is it?
When a business is incorporated, it is no longer owned by the trader; it is owned by the shareholders. Although the previous ST is likely to be ‘a’ or even ‘the only’ shareholder, legally, they own shares and not the business.
Merging personal and business assets and expenses might have been acceptable when the business was an ST, but these practices will no longer be possible when the business is a separate legal entity, and this can be tricky for a long-term landlord used to their ways and practices.
Other issues
There is the possibility, when holding a residential property worth more than £500,000 within a limited company, for the annual tax on enveloped dwellings. This is unlikely to be chargeable as there is an exemption for properties being let out for a gain. However, if circumstances change, it is important to know that this charge is lurking in the wings.
Finally, increasing the portfolio could become more costly under a limited company. For example, stamp duty land tax (in England and Northern Ireland) is charged at 15% for properties purchased at a cost of over £500,000, whereas, if purchased personally as an ST, although an extra 3% is levied (being an additional residential property), the total percentage for a property costing under £925,000 is only 8%.
Practical tip
Despite there being many benefits of incorporation, it is not appropriate for all landlords, and each landlord must look at their own particular situation now and their plans for the future to establish if incorporation is the answer.
