Less tax equals higher net profit when you buy properties as a limited company
Many property investors are buying properties as a limited company to invest in property rather than investing in their own personal name. The reason? Tax. You could increase your property investment profits as a limited company.
Tax – not the reason to invest, but the consideration for how to invest
I’ve always said that you shouldn’t invest purely for tax reasons. If an investment is good to make, it’s good to make. I stand by this.
But the government has moved the goalposts so far on property tax that you must consider its impact before you invest. When you do this, you can structure your investment to mitigate for the extra tax the government want to snatch from you. This is especially the case if you are a higher rate taxpayer, or if your rental income would put you at the higher rate.
What extra tax might you pay as a personal investor?
The government has changed a lot of property taxes in recent years. This includes the change of how maintenance costs are treated – you can now only deduct the actual costs and not an automatic 10% of rental income.
However, the major expense when you invest in property is the mortgage interest you pay. The ability to deduct this from your rental income when calculating profit is being phased out.
By 2020, you won’t be able to offset a penny of your interest payments against your rental income. Instead, you’ll only be able to claim tax relief against your mortgage interest payments. And only at the basic rate of income tax – that’s going to cost you a lot of money if you are a higher rate taxpayer.
Here’s an example of how this could work out for you:
| Item | Before 2016/17 | After 2020/21 |
| Rental income | £14,400 | £14,400 |
| Mortgage interest | £7,500 | – |
| Costs (e.g. property management, etc.) | £1,900 | £1,900 |
| Taxable profit | £5,000 | £12,500 |
| Tax on profit (@40%) | £2,000 | £5,000 |
| Mortgage interest | – | £7,500 |
| Tax relief on mortgage interest (@20%) | – | £1,500 |
| Net profit | £3,000 | £1,500 |
This is a 50% cut in your profit!
How investing as a limited company could benefit you
Investing as a limited company has several tax advantages. For property investors these include:
- Mortgage interest costs are counted as an operating cost
- Your property profits are taxed as corporate profits
- The rate of corporation tax in 2020/21 will be 17%
What effect do these advantages have on your property profits? Let’s look at how much tax you would pay on the above property investment if you invested as a limited company:
| Item | After 2020/21 |
| Rental income | £14,400 |
| Mortgage interest | £7,500 |
| Costs (e.g. property management, etc.) | £1,900 |
| Taxable profit | £5,000 |
| Tax on profit (@17%) | £850 |
| Net profit | £4,150 |
That’s right. As a buy-to-let investor who pays tax at the higher rate, on this investment you would make £2,650 more net profit than by investing as a limited company rather than in your personal name. If you pay tax at the additional rate, the tax savings are even higher.
Why this is relevant to basic rate taxpayers
If you’re a basic rate taxpayer, the difference in net profit will be far less. In our example above, you’ll be only £150 worse off (a profit of £4,000 vs £4,150).
However, because your profit and tax liability are calculated differently, you could find that your gross rental profit pushes you into the higher tax bracket.
Or perhaps you may get a better paying job or receive a pay rise that puts you in a higher rate tax bracket.
Maybe you anticipate buying more properties, building a portfolio that increases your rental income and profits with each addition.
The thing is, you cannot afford to ignore the tax changes, and what they mean to you now or may mean in the future. And here’s another reason why…
You can’t simply transfer an existing portfolio into a limited company name. They must be sold into the company. This could mean paying capital gains tax, stamp duty, and perhaps early redemption charges on your existing buy-to-let mortgages.
Get advice now
The examples I’ve shown are generic. They aren’t specific to you. Your personal situation, investment objectives and tax circumstances must be considered fully when you’re deciding how to invest. You must take professional advice.
Contact Gladfish today on +44 207 923 6100 and get the ball rolling. Book a strategy consultation. Together, we’ll assess your current financial position and investigate how your property investment should best be structured, to meet your unique investment objectives.
Live with passion and fun,
Brett Alegre-Wood
