Name: Aileen Gates
Company: Campbell Dallas
Aileen Gates is a partner at Campbell Dallas, Chartered Accountants. Email Aileen with your financial queries and she will answer in following issues of BWS magazine. e: firstname.lastname@example.org
Buy to Let: To Incorporate or not to Incorporate?
In a previous BWS article I discussed a series of recent tax changes set to significantly impact the buy to let sector; in particular the restriction of interest relief on property related loans. As a result of these changes many buy to let investors are asking if incorporation could mitigate the impact and in this month’s article I explore the pros and cons of incorporating a rental business.
What are the potential tax advantages of incorporating my buy to let business?
• Loan interest
As indicated in the previous article, from 2017 onwards the deductibility of loan interest against rental profits for individuals will be restricted, with relief only being given at the basic-rate from 2020. To put this change into context a landlord (who pays tax at 40%) currently receiving £20,000 of rent with interest costs of £13,000, will pay tax of £2,800 to HMRC leaving the landlord with £4,200 in her pocket. From 2020 the tax charge in this scenario increases to £5,400, an increase of 93%! The net return to the landlord has dropped from 21% to 8%. The change to interest relief will not apply to companies which will continue to be able to deduct loan interest from rental income when calculating taxable profits.
• Corporation tax
Rental profits arising in the business will be taxed at the corporate rate of 20% rather than income tax rates of up to 45%. Rental profits can be paid out as dividends or reinvested in the company as desired, unlike a sole trade or partnership where all profits arising will be subject to income tax.
• Capital Gains Tax (CGT)
When properties held by companies are disposed of, the resulting capital gain will be taxed at 20%, rather than the 28% rate on residential property disposals faced by higher-rate taxpayers.
• Business risk
A company has limited liability which protects a shareholders personal assets from business risks.
What are the potential issues with incorporating?
The main concern for many when considering incorporation will be the CGT charge triggered by transferring the properties into a company. The taxable gain will be the current market value of the properties less the original cost. In addition, a Land and Buildings Transactions Tax Charge will arise when properties with a combined value exceeding £40,000 are transferred to a company. The 3% LBTT additional dwelling supplement will also apply unless 6 or more properties are transferred together.
Extracting profits from a company via dividends will incur an income tax charge. However from April 2016 each taxpayer is entitled to an annual £5,000 tax free dividend allowance.
There will of course be non tax considerations too, such as the need to re-finance on incorporation as the company is a separate legal entity and the cost associated with preparation of annual company accounts etc.
Although there may potentially be CGT and LBTT charges associated with transferring properties into a new company, for many investors the potential savings once the properties are in the structure will make incorporation beneficial in the long term. The decision is one of weighing up the short-term costs and the long-term benefits.
Whether incorporation is the best option for you will depend on your personal circumstances and your future intentions and should be discussed with a professional tax adviser.
If you would like to explore this issue further or have any general tax questions, please do not hesitate to contact Aileen Gates at email@example.com or telephone us on 0141 886 6644