Is direct property investment best for you?
One of the most common questions we’ve been asked during the last few months is whether owning properties directly is still the best way to profit from UK property investment opportunities. Mostly, the question has been prompted by the changes to the tax regime and how mortgage interest tax relief is changing.
I wish there were an easy answer, but there isn’t. When it comes to which structure is best for your property investment, it is most definitely ‘horses for courses’. There is no standard answer, because your investment objectives, tax position, personal circumstances, and so on are unique.
Each investment structure has unique characteristics. Whether you’re a new investor or already own a property portfolio, you’ll need to seek advice from your accountant about which structure is best for you. Now, I know how technical accountants and solicitors can get. So, over the course of my next few blogs, I am going to explain the different ways to invest in UK property investment opportunities, in plain English.
In this article, I’ll discuss the most common method of investing in UK property: direct investment. In the following three articles, I’ll look at partnerships, limited liability partnerships, and limited companies. It’s the knowledge you’ll need when you speak to your tax advisor.
Direct ownership of UK property
There are several advantages of owning investment property directly. One of these is that raising financing is usually easier and cheaper than getting a mortgage as a limited company, for example.
Owning property directly is easy to do. Although you should employ the services of mortgage brokers, solicitors, accountants, and other advisors with specific buy-to-let property expertise, buying property is familiar to most people. If you’ve bought your home, you’ll know the basics of investing in a residential property – this simplicity is one of the major benefits of property investment.
Direct property ownership and tax
When you invest in property directly, all taxes will be charged on a personal basis. It means that your rental income is charged at your marginal tax rate. Now here’s one of the major reasons you might decide to consider moving from direct ownership to a limited company or partnership structure:
By 2020, higher rate taxpayers will not be able to claim tax relief on mortgage interest on their marginal rate. Instead of getting full tax relief on mortgage interest, it will be limited to 20%. Higher rate taxpayers could find themselves paying thousands of pounds more in tax every year.
However, it’s not all bad news on tax. When it comes to capital gains tax, directly held investment property benefits from the use of your personal capital gains tax allowance. Currently (2016 and 2017), the annual capital gains tax exemption is £11,100 per person. If you own an investment property jointly with your spouse, the first £22,200 of capital gain is effectively tax-free.
Above your CGT allowance, CGT will be charged at either 18% or 28%, dependent on your marginal tax rate.
In a limited company, you’d be liable to corporation tax on that profit – at the current rate of 20%, you could find yourself paying as much as £4,440 extra in tax should you sell your investment property.
Holding investment properties in joint names
If you own investment properties in joint names (and this includes owning in a partnership structure), you’ll be charged income tax and capital gains tax in the proportion of your shareholding.
If you own property directly as a husband and wife (for instance, as tenants in common), the rental income will be deemed to be split 50/50. The CGT allowances can be used separately.
You can build tax efficiency by owning property jointly and directly. However, if you already own a property and want to transfer a portion to your spouse, you could get caught in a stamp duty land tax (SDLT) trap – the transfer is exempt from CGT and IHT, but stamp duty will still be chargeable.
Direct property investment ownership summed up
Owning investment property directly is relatively easy, and you might be able to double up on your tax allowances when considering income and capital gains tax. Because of the SDLT rules on transfer of assets, you should consider investing jointly from the outset. Having said this, the changes in mortgage interest tax relief may make it more efficient to hold property in the sole name of the spouse with the lowest marginal income tax rate.
As a direct property holder, buying and selling are easier, as is raising finance for investment. Buy-to-let mortgage interest to direct investment property owners is usually charged at a lower rate than it is to limited companies.
As you can see, while direct ownership is the easiest ownership structure for property investment, whether it is right for you (and how ownership between spouses is divided) depends on the answer to a number of questions. Depending on the answers to those questions, it might be more beneficial to hold investment property in a partnership or limited company structure.
My advice is to speak to your accountant before deciding how to structure your property investment – one with specific knowledge and expertise in investment property. If you don’t have an accountant, or you don’t consider yours to have the experience needed, contact one of our team today on +44 (0)207 923 6100– we’ll be happy to recommend a suitable accountant to help you.
Partnerships as property investment vehicles
UK property investment can be made using several different structures. Having discussed the pros and cons of direct property investment above, here I’ll be looking at partnerships.
What is a partnership?
A partnership is simply an agreement between two (or more) people to own a business between them. It’s a step up from direct ownership, putting what may otherwise be a ‘friends’ agreement’ onto a business footing. Each partner owns a share of the business, and the profits and income are directly distributed to them (as are losses). Each partner is responsible for paying income and capital gains tax personally – this eliminates the double taxation that can occur in limited company structures: a major advantage over company structures.
What is the difference between limited liability partnerships and general partnerships?
In a general partnership, the partners are liable to make good all losses incurred by the partnership. The partners could act independently on behalf of the company without gaining the consent of the other partners.
A limited liability partnership (LLP) is more formalised. There is an agreement between the partners as to the role and responsibilities of each partner, and partners can elect to be non-active in the business. The liability of each partner is limited to their initial contribution into the partnership. The partners can tailor how the partnership operates to benefit from each partner’s specialisations, though this can also lead to a lack of control of partners who have no management function.
In both types of partnership, the profits and income are distributed in line with the partners’ share of the business. It is then the responsibility of the individual to declare and pay their tax.
It’s worth mentioning that limited partnerships and limited liability partnerships operate quite distinctly from each other. In a limited partnership, at least one general partner must manage and take on all the risk of the business’s operations – the other passive partners have no liability.
Stamp duty land tax and partnerships
If you transfer properties into the partnership, you may have SDLT to pay (just as you would have to if you were to transfer the property to your spouse).
To recap about partnerships
- The profits made within the partnership, whether made by capital gain or rental income are divided between the partners.
- Each partner pays tax at their marginal rate on their share of the profits.
- The shareholding of the partnership can be changed year-to-year so that partners can benefit from their individual tax positions.
- Partners also pay their taxes on the profits from their partnerships on an annual basis, and not via PAYE – this can be a handy cash flow benefit.
- SDLT may be payable on transfers into the partnership.
- Partners in a limited liability partnership have their liability capped at the amount they contributed into the partnership.
In a company structure, profits are taxed at 20% (being the rate of corporation tax). Distributions (by way of wages, bonuses, and dividends) are all liable to tax (though the first £5,000 of dividends is tax-free).
As with a company structure, mortgage interest is treated as an expense within a partnership, and so is deducted in full from the income before profits are distributed to the partners. This means a potential saving for higher rate taxpayers, though the interest relief can’t then be claimed against the individual’s tax liability.
With these tax advantages, it’s not surprising that new property investors are increasingly considering investing in a limited liability partnership structure. However, they can be expensive to set up and transfer existing properties into, so before you jump into setting up an LLP you should seek advice and weigh up the advantages and benefits versus both direct investment and investing as a limited company.
If you’d like to speak to an accountant with expertise in the property investment and partnership and company process, 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.
Is a limited company a viable vehicle for your investment?
As I’ve discussed above, 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, I’ll examine 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 teamtoday on +44 (0)207 923 6100 we’ll be happy to recommend a suitable accountant to help you.
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