Investing in property within a limited company structure needs to be considered carefully before jumping in.
One of the first questions you should ask yourself is “Are planning to take income from your property portfolio?”, then “when?” I'll explore how a limited company structure affects the property investor who wants to supplement their income and those that want to pass their buy-to-let properties onto their children when they pass away.
Do I need the profit from buy-to-let properties now?
In my last post, I discussed selling investment properties and the CGT that you'd be liable to pay. So this question really relates to how rental income is taxed.
For many buy-to-let investors and landlords, the investment produces rental income that can augment their current income. If the investor uses a property manager to manage the properties for them, then the rent potentially becomes a much more effortless or passive income. When properties are held in your own name, the net income is added to your other earnt income, then taxed at your marginal rates. If you’re a higher rate taxpayer, your rental income is going to be taxed at up to 45%.
Within a limited company structure, rental income made by investing in property is treated as business income. If there is a profit, then it is taxed as corporation tax at 20% (in 2016).
You might think you have saved 25% tax, but under the new dividend tax rules, you can take £5,000 of dividends tax-free. After this the remaining dividend is still going to be charged tax based on your margin rate of personal tax which is between 7,5% and 38.1% (if the limited company is set up between husband and wife (and both pay tax at the top rate), that amount doubles to £10,000.)
This doesn’t mean that setting up a limited company for property investment is right for everyone who wants to benefit from income now (though if you’re a foreign investor, setting up a limited company offers a range of specific benefits and disadvantages to your property investment portfolio). The actual benefit depends on how much income you need and your current tax position, and how the extra income affects your tax position.
Am I planning to use buy-to-let profits as my income in retirement?
This is much more straightforward.
If you're investing in property as an alternative to a traditional pension plan (and many property investors have this as their main goal), then it may be better not to invest via a limited company. Again, this will depend on your anticipated tax position when you retire. For example, if you have no other income then you can use your personal allowance against the rental income from your investment properties and pay less tax than you would under a company structure (which will have paid corporation tax).
Do I want to leave my buy-to-let portfolio to my children?
This is where things get really interesting. Inheritance tax is charged at 40%, and by investing as an individual the buy-to-let properties you own form part of your estate and will, therefore, be liable to inheritance tax.
When investing in property via a limited company structure, you could make your children shareholders. While you are alive, your children can benefit from up to £5,000 per year in tax-free dividends, and as the value of the portfolio increases, so too would the value of their shareholdings, with no IHT to pay (though there may be other personal taxes to pay).
In general, if you want to pass your buy-to-let properties on to your children and your estate is above the value of the IHT threshold, you should consider investing in property within a limited company structure.
In partial summary…
In my last post and this one, I’ve answered the six key questions that a property investor should ask themselves before deciding to open a limited company for investing in property. However, that doesn’t mean you should rush right in. There are plenty of other things to consider. In the third and final part of this series, and to add a little balance to the subject, I’ll look at the four main disadvantages of investing in property via a limited company.
For now, just add in the comments below and ask yourself, what are your investment objectives? How concerned are you about the tax payable on property investment? Your question could be on every reader's mind.
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PS One of the key understandings about a limited company is that it is a seperate legal entity and therefore pays tax seperately to you as a person. So if you have a company, it has to pay tax and then when you receive the income (in the form of a dividend or earnt income) you will have to pay tax as a natural person.