Lee Sharpe looks at the ‘pros’ and ‘cons’ of incorporating a property letting business.
There are a number of reasons for running a property letting business (BTL) through a limited company. They are not the same as for a property development company, although there is some overlap. Here again, a limited company will not always be advantageous.
The key point to bear in mind is that property letting counts as an investment activity, so:
- there are no National Insurance contributions (NICs) due on BTL rental business profits;
- which means that the effective tax rate for the individual running a BTL business will often be lower than the corresponding rate for a similar level of self-employed trading profits;
- there are differences in the treatment of losses;
- property letting businesses are ineligible for capital gains tax (CGT) entrepreneurs’ relief (aside from the relatively specialised area of furnished holiday lettings); and
- the sale of an investment property will generally rank for CGT, rather than a trading profit subject to income tax (but see the important caveat below).
Advantages of company structures
1. Low tax on profits
The UK corporation tax rate is currently 19%, and is set to fall to just 17% from April 2020. This compares most favourably with personal income tax, which may be taxed as high as 45% at the additional rate (broadly where taxable income exceeds £150,000).
However, the effective rates outside a company are not as high as for property development (trading), where NICs would also be in point. As before, one will almost certainly need to pay additional tax to extract those post-tax profits from a company to personal funds.
2. Running a property letting business through a company
When comparing profits between trading corporates versus non-corporates, I made the point that fluctuating profits could be quite heavily taxed under income tax (for example, where selling only one or two developments a year could cause income peaks and troughs from one year to the next); this is less likely to be an issue for BTL landlords.
3. Pension contributions
Unlike property development, ordinary BTL profits do not count as ‘relevant earnings’ for the purposes of pension contributions, so individuals may pay only £2,880 (net) each tax year, in the absence of any other earnings (and again ignoring furnished holiday lettings).
However, salary from a company that likewise runs a BTL business does count towards making pension contributions, allowing someone to make much larger contributions in the right circumstances.
4. Cash basis for landlords
While ordinary BTL businesses with (broadly) gross rental incomes up to £150,000 a year are automatically corralled into the new ‘simple’ regime, companies are not.
I have written previously that the new cash basis for landlords is anything but simple and may well end up costing landlords time and money.
5. Property losses
Non-corporates may generally set net property losses only against future profits from the same rental business (although that normally encompasses all BTL properties), but corporate losses may be set against the total profits (from any source) arising in the current year, and against future total profits as much or as little as desired.
They can also be relieved against same-year or future profits of other companies in the same group (there is, however, a restriction that applies when losses and profits are very large – into the £millions). So, corporate rental losses can be very much more flexible than for individual BTL landlords.
6. CGT rates
Landlords will be painfully aware that the main rate of CGT when disposing of dwellings is 28%, and 18% for any capital gains that fall below the higher rate threshold (basically £50,000 in 2019/20), but only 20% and 10% respectively for practically any other category of asset.
Companies are subject to the same rate whether it be rental profits or capital gains, so they initially compare quite favourably – although there is still the potential tax cost of extracting the corporate funds into the hands of the director/shareholder; however, a director/shareholder could sell the company shares for a maximum CGT rate of 20%, even if that company owns only residential properties.
Unlike individuals, companies do not have a CGT annual exemption (£12,000 in 2019/20) and there is no higher rate threshold below which CGT is taxed at only 10% or 18% depending on the nature of the asset; for many BTL landlords, however, annual exemptions and lower CGT rates are a relatively minor consideration, given the scale of the gains at stake.
Finally, in relation to CGT, note that UK-resident companies will not be subject to the imminent 30-day window for paying CGT on account after completing the sale of a UK residential property; individuals will be subject to the new regime from 6 April 2020.
7. Dwelling-related loans
Perhaps the single biggest motivator for running a BTL business through a company is the escalating restriction of tax relief for mortgages and other finance costs for residential property profits subject to income tax.
By 2020/21, 100% of any ‘dwelling-related loans‘ will be disallowed, with a basic rate or 20% tax reduction allowed in their stead. BTL businesses run through companies are basically unaffected by the restriction.
8. Limited liability
Just as with property development businesses, companies benefit from limited liability (although banks and similar lenders will often demand personal guarantees that can override such protection).
9. Segregation of activities
A classic scenario would be for a person to run a holiday home or B&B type activity in one company, and his or her BTL business in another.
Amongst other things, the first company could be ‘fully’ VAT registered, while the second could remain VAT-exempt.
Disadvantages
BTL companies suffer the same issues in relation to administration and privacy that property development companies do, but the remainder of the article will focus on profit extraction.
It’s not your money (yet) #2
Last month’s table compared various methods of profit extraction for a trading company; this month’s table will compare the results for a BTL investment company with its unincorporated equivalent at different levels of profit and gearing, and assuming that interest is wholly disallowable as at 2020/21:
|
Profits / Interest |
Unincorporated |
Limited Company |
Comments |
|
£30,000 but no mortgage* |
No NICs, no interest disallowance; landlord still in basic rate band and gets £26,500 net |
£24,673** |
The company route is significantly worse when compared to last month’s property development scenario because the unincorporated landlord is not suffering NICs; and this is before considering the additional cost of running a company |
|
£30,000 after £20,000 annual interest |
No tax restriction of interest cost because just under higher rate threshold, so still £26,500 net |
£24,673 |
Company suffers no interest restriction regardless but still worse off |
|
£60,000 no mortgage |
Unincorporated landlord is now a higher rate taxpayer but without any interest costs will get £48,500 net |
£47,606 |
Company is still worse off, although the margin has narrowed because dividends are taxed a little less heavily |
|
£60,000 after £50,000 interest |
After significant interest costs, the tax restriction lowers net yield to just £36,500 |
£47,606 |
Corporate yield unaffected by interest restriction, resulting in a very substantial relative saving, just by ‘standing still’ |
*Assumes taxpayer has no other income in 2020/21
**Assumes salary of £8,400 and the rest of company’s profits paid out as dividends
Conclusion
The above table and underlying assumptions are quite simplistic, but nevertheless illustrate that in many cases landlords may well be better off keeping their properties out of a company – and they will also be aware that there are significant tax hurdles including CGT and stamp duty land tax (or similar in Scotland and Wales), to consider when contemplating the transfer of a pre-existing BTL portfolio into a company wrapper.
Nevertheless, where the individual has substantial non-BTL income, or interest costs are significant, a company can offer some respite from the worst effects of the interest restriction.
Professional advice is strongly recommended, however, as incorporation and running a company can be quite onerous without proper planning and preparation.
