In most circumstances, it makes sense for higher-rate taxpayers to purchase rental properties through a limited liability corporation. It provides total tax reduction on mortgage interest, access to lower tax rates, and greater flexibility.
It also places your development company on a firmly professional basis, which may be advantageous when trying to convince investors and lenders.
However, each case is unique, and it’s always advisable to seek professional guidance – especially as the UK Government continues to make regulatory changes primarily through tax policy that make the decision more nuanced each year.
Are there any drawbacks when buying property through a limited company such as raising finance?
The first obstacle you may have is obtaining finance from an appropriate lender. Most buy-to-let lenders do not offer LTV finance above 50% to limited liability companies; if they do, directors are often required to provide a personal guarantee. Additionally, the interest rates on such mortgages may be more significant.
Moreover, if you did not form your business before acquiring the property, you would have to transfer or sell the property to your new company. Given that the value of your property is likely to have grown since you initially got it, this would trigger capital gains tax. On the property’s buyback, stamp duty would also be required.
You must either pay yourself a salary or a dividend to access rental income. These payments are subject to income tax, and rental income paid as dividends cannot be deducted as a business expenditure.
As Finbri Development Finance explains, “Although financing via an SPV or limited company can throw up some challenges, you can offset 100% of mortgage interest against corporation tax in the UK, instead of the 25% offset if you purchase the property personally. If you sell a property purchased via a company, you will only incur the corporation tax on the profits, ranging from 19% to 25%, depending on how much profit the company makes. There are many other benefits that a chartered accountant could advise you on, so my advice would be to seek their professional guidance before purchasing an investment property.”
Transferring ownership into and out of a business
If you currently own the properties and wish to transfer them to your new limited liability business, you might be subject to capital gains tax (CGT) and stamp duty land tax (SDLT). This is because you, as a person, must sell the property to your business at a fair market price. Therefore, as an individual, you may be liable for CGT while the firm is responsible for SDLT.
Still, the tax savings may make this advantageous, particularly in the long term, so you must prepare carefully before making a decision.
In general, however, it is advisable to incorporate a limited liability company before acquiring property, to avoid the CGT issue.
Foreigners and British limited businesses
If you reside abroad and wish to invest in UK property, the choice demands further consideration.
The Government provide the following advice,
“Non-UK residents may acquire property using UK resident companies, allowing them to indirectly enjoy the economic benefits of property ownership. Without any additional rules, the surcharge would not apply where non-UK resident individuals use a UK resident company to purchase a dwelling. The second condition provides an additional residence test to UK resident close companies which takes their underlying ownership into account.
“For the purposes of the surcharge, a company is non-resident in relation to a chargeable transaction if on the effective date of the chargeable transaction, the company is UK resident for the purposes of the Corporation Tax Acts, but:
- is a close company;
- meets the non-UK control test in relation to the transaction; and
- is not an excluded company.”
Essentially, as long as the company is incorporated and resident in the UK then the 2% SDLT surcharge won’t apply.
The impact of governmental restrictions
A few years ago, obtaining a buy-to-let mortgage was tax-efficient for residential landlords. It allowed them to deduct mortgage interest and financing costs from taxable rental revenue before tax payment, saving them thousands of pounds.
Even if you had never considered property investment before, there was a compelling reason to enter the industry. This was especially true in the aftermath of the global financial crisis of 2008, when falling interest rates made property investment an enticing alternative to traditional savings vehicles. Add into that mix the fast appreciating asset that had been UK property and increasing rents, the property investment opportunity seemed too good to pass up.
In reaction to more of the UK’s limited housing stock being purchased for buy-to-let investments, the government moved to rein in the sector by instituting a 3% stamp duty extra on additional property purchases.
The government then decided to restrict the amount of mortgage interest assistance offered. Mortgage interest relief decreased by 25% each year beginning in April 2017 and was replaced with a basic-rate (20%) tax credit starting in April 2020.
This negatively impacted sole proprietors and partners in the higher (40%) or additional-rate (45%) income tax categories the most, causing a rise in property investors incorporating their landlord enterprises.
By 2019, the majority of buy-to-let investors, regardless of the size of their portfolios, were reportedly acquiring new properties through limited liability entities.
Why establish a limited liability company?
It’s simple: limited liability corporations can deduct all their mortgage interest from their rental revenue profits.
They then pay corporation tax at 19% (on the first £50,000 of profits only from 1 April 2023 if you do not own other businesses), which provides substantial savings compared to the ordinary marginal rates of 40% or 45% for sole proprietors and partnerships.
A limited liability entity can also provide a great deal of freedom in how you harvest profits from your property investment business. To maintain access to the state pension and other benefits while minimising personal income tax, a combination of a minimum salary to satisfy national insurance contributions and the rest in dividends is standard accounting practice today.
Like in every other industry, limiting personal liabilities conferred by incorporation is advantageous in the property sector. As a director, your assets, such as the family home, would not be in danger if the company experiences financial difficulties, unlike if you were a sole trader.
It seems like a no-brainer, and for most developers, this will be the path to take once you begin investing in buy-to-let properties.
In summary
As this article has discussed, there are many advantages to acquiring rental property via a limited liability company but as each situation is different, it’s always best to discuss your options before making such an important decision.