Is a limited company a viable vehicle for your investment?
As I’ve discussed in my last two articles, there are several structures that you can use to invest in UK property. Having looked at the pros and cons of direct property investment and the difference between general partnerships and limited liability partnerships, in this article, I’ll be examining how investing in UK property using a limited company structure is a mixed bag for tax efficiency.
Slash the tax you pay on mortgage interest
UK property investment is going to get a little tougher for higher rate taxpayers over the next three years. The mortgage interest rate tax relief will be limited to 20% from 2020, and that will reduce the profits that higher rate taxpayers can bank from their buy-to-let properties. By making your UK property investment through a limited company instead of directly, additional rate taxpayers will effectively reinstate their full mortgage interest tax relief (back to 45%). It is because the interest paid on capital loans by a company is counted as business expenses.
However, as ever, this is not the full story. If it were, the decision about how to invest in property would be far easier for higher rate taxpayers. Let’s look at a couple more advantages before the disadvantages.
Cap the tax on rental income
Tax on rental income where property is held either directly or through a trust is taxed at rates up to 45%. Within a limited company structure, profits and income are subject to corporation tax rates. Currently that is 20% but is set to reduce to 19% in April 2017 and then will be cut further to 18% from 2020. If you’re an additional rate taxpayer and want to use rental income to repay the mortgage, you’ll have 80% of the profit available to do so instead of 55%.
More cash to reinvest
If you want to build a property portfolio, the way that profits are taxed will help you build your portfolio more quickly. There’s no income tax on the retained profits, so here again additional rate taxpayers will have more cash to reinvest.
£5,000 tax-free from dividends
Each year, you are allowed to take dividends of up to £5,000 tax-free. For dividends above £5,000, the tax you pay depends upon your marginal tax rates. Basic rate taxpayers will pay tax at a rate of 7.5% on the dividends, higher rate taxpayers will pay 32.5%, and additional rate taxpayers will pay 38.1%.
Don’t forget, too, that dividends are paid from company profits, on which corporation tax has been paid – so the £5,000 tax-free benefit is negligible for basic rate taxpayers.
Capital Gains Tax – a mixed bag of benefits
Investors pay capital gains tax at a rate of either 18% or 28% when they sell a property held directly. Within the limited company structure, capital gains are treated as profits and taxed at 20%.
In the limited company, you’re also able to increase the cost base by inflation, further reducing the capital gains tax, which you can’t do when holding property directly.
However, companies don’t get an annual CGT exemption – direct investors pay no tax on the first £11,100 of capital gain.
As with income from a property investment, it’s when you want to take the profit out of the company that the tax benefit can be hit hard. For example, let’s assume you make a capital gain of £111,100 on the sale of an investment property:
As a direct holder and additional rate taxpayer, you could use your CGT allowance and pay capital gains tax of £28,000 on balance. You’d be left with £83,100.
In a limited company, though you’d only be charged 20% tax on the profit (£22,220) when you take the proceeds out as dividends you’ll be charged a further 38.1% tax on £83,880 (£111,000 – £22,220 (tax) – £5,000 (tax-free dividend)). The total tax charge on the £111,100 profit will be approximately £54,178. You’d be left with around £56,922.
Not all sunshine and roses for UK property investment through a limited company
While paying only 20% tax on capital gains and rental income profits sounds like a great deal, and being able to write off mortgage interest is also a valuable commodity for the investor in UK property, as you can see there are also disadvantages.
If you’re planning to reinvest profits and want to build your portfolio quickly, then investing via a limited company may be a good option. If you want to add shareholders at a later stage, this is easier to do than the legally complex world of property co-ownership.
However, remember that when you take profits out of the company you will effectively be paying tax on money on which you’ve already paid tax. On top of this, you’ll have extra admin work to do, such as filing company returns and taxes (which can also be costly).
Get advice before acting
I can’t stress enough how important it is to get expert advice before structuring or restructuring how you invest in UK property. As you’ve read the three articles in this mini-series about investment structures, however, you invest has both advantages and disadvantages. How your investment benefits depends on your current circumstances and your future goals.
If you’d like to speak to an accountant with experience in UK property investment and the expertise to set up the best structure for your investment, feel free to contact one of our team today on +44 (0)207 923 6100– we’ll be happy to recommend a suitable accountant to help you.
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