"Is it best to own your rental property business personally or through a limited company?"
The answer is...it depends!
Limited company - if you have high finance costs, you’d like to reinvest your profits to purchase more property and/or you’d like to draw down your profits in a different tax year at a lower tax rate (e.g. you’ll be drawing down your profits in retirement or not within the dreaded £100,000 to £125,000 zone), it would potentially be worth owning your property portfolio through a limited company.
Personally owned - if you have low finance costs, you'd like to draw down your profits when you earn them and/or you're a basic rate taxpayer, it would potentially be worth owning the property portfolio personally.
It really depends on your specific circumstances whether you should become a limited company or not. Get in contact with us on 0118 3800 363 or email us, if you'd like to discuss your personal scenario.
Since 6 April 2017, the government have started to restrict tax relief for finance costs on personally owned property. This restriction will gradually increase over a 4 year period meaning that you will only be able to claim relief at 20% if you pay income tax at 40% or 45% (we'll explain this a little bit better in the 'rental profits & finance cost restriction' example below).
Before the change, advantages of owning property through a company were limited. However, finance costs are not restricted through a company and so this can be a huge benefit, especially if you're borrowing a lot of money to fund your property portfolio.
Profit Types
To give you a grounding in property tax we need to describe the two types of profit made through a property business; rental profits (profits from the day to day running of the business) & capital growth (increase in property value).
If you own property personally (i.e. not via a limited company), they are taxed separately by way of:
Personal tax on the rental profits (see 'rental profits & finance cost restriction' below).
Capital gains tax (CGT) on the capital growth (see 'capital gains tax (CGT) on capital growth' below).
However, a company pays corporation tax (currently 19% but falling to 17% by 2020) on both rental profits and capital growth and then personal tax once you draw down money from the company by way of a dividend (£2,000 tax free, 7.5% basic rate, 32.5% higher rate, 38.1% additional rate).
Rental Profits & Finance Cost Restriction
For limited companies, there will be no restriction on your finance claims.
For a personally owned rental business, let's assume you also have a job that pays you £60,000 through PAYE (i.e. you're a 40% taxpayer), your rental business has income of £40,000, finance costs of £20,000 and other expenses of £10,000 (e.g. repairs & letting charges) & no other income.
How to calculate profits for limited companies and for personally owned properties before 6 April 2017:
Add: Rental Income: £40,000
Less: Finance Costs: £20,000
Less: Other Expenses: £10,000
Profits: £10,000
For personally owned properties, profits are then taxed at 40%.
Tax Due = £10,000 x 40% = £4,000
How to calculate profits for personally owned properties from 6 April 2020:
Add: Rental Income: £40,000
Less: Other Expenses: £10,000
Profits: £30,000
For personally owned properties, profits would then be taxed at 40% on the £30,000 profits but then you could reduce your tax by 20% of the £20,000 finance costs.
Tax Due = (£30,000 x 40%) - (£20,000 x 20%) = £8,000
Capital Gains Tax (CGT) on Capital Growth
Capital Gains Tax (CGT) is payable on the capital growth of any personally owned property. You have an annual tax free amount that no tax is payable on - currently £11,700 for 2018/19 and then tax is payable at 18% for basic rate taxpayers and then 28% for higher rate taxpayers. For example:
A property sold for a £60,000 profit (i.e. £300,000 purchase price, £40,000 property improvements (e.g. an extension) & £400,000 sale price) whereby the owner has other income of a £30,000 PAYE job and £10,000 in rental profit. The calculation would be as follows:
£60,000 (profit) - £11,700 (tax free amount) = £48,300 (profit subject to capital gains tax)
£45,000 (basic rate) - £40,000 (other income = £30,000 PAYE income & £10,000 rental profit) = £5,000 x 18% = £900
£48,300 - £5,000 (higher rate) = £43,300 x 28% = £12,124
Total tax due = £900 + £12,124 = £13,024
Delayed Tax Payment
This is a really important point - personal tax is only payable if you pay money out of the business as a dividend. If you pay money out as a dividend, more often than not you pay more in tax than if you had owned the property personally.
Assuming you're a higher rate taxpayer, you would pay (ignoring the tax free dividend rate for simplicity):
Personal: 40% on rental profits and 28% on capital growth
Company: 19% corporation tax & then 32.5% personal dividend tax = 1 - ((1 - 0.19) x (1 - 0.325)) = 1 - (0.81 x 0.675) = 0.453 = 45.3% total tax
It's therefore clearly less tax efficient to pay profits out of the company.
IMPORTANT! However, if you don't pay the profits out as a dividend, you only pay 19% corporation tax (falling to 17% in 2020) which is much lower than the 40% and/or 28% tax on personal property. If you reinvest the money you've effectively saved in tax at say 10% per annum, you'll probably be better off in the long run. In property, capital is king and this is a very effective way of having more cash at your disposal.
Other Things To Consider
Primary Residence - if you have ever or will ever live in the property you can usually get some large tax deductions if you own the property personally instead of through a company. The longer you've lived there, the larger the tax benefit.
Limited Liability - if you have significant personal assets (such as a house and savings) they cannot be used to pay for a company's creditors (people the company owes money to) if you have acted reasonably and in the best interests of the company. Some mortgages may need a personal guarantor which would negate most of the limited liability benefit.
Mortgage Fees - can be more expensive when buying through a limited company so check with your mortgage provider.
Stamp Duty/Capital Gains Tax - you may have to pay stamp duty and/or CGT if transferring a personal property into a limited company (or vice versa).
Spouse - tax planning would be required if you had a spouse - especially if they were in a different tax bracket to you.
Accountancy Fees - it takes more time and expertise to file limited company accounts as they are much more complex.
Complicated - it's a lot harder to explain how to run a limited company - you'll need to keep money in the company bank account in order to pay your tax bill at the end of the year. We can talk you through this complexity every step of the way though.
Accounts - your limited company annual accounts which show your assets and liabilities (but not your income and expenses) are shown online at Companies House for public inspection.
Bank Fees - if you own properties personally you can use your own personal bank account whereas a limited company must have a company bank account with fees currently at around £7.50 per month - the first 12 months of bank fees are generally free.
Larger Fines - the fines for late submission of documents are a lot higher for a limited company.