Should I invest in property through a limited company?
This has been a common question asked of accountants for many years, and with the buy-to-let tax changes announced by the Chancellor in 2015 it is a question that is likely to be asked on a more frequent basis.
So, what’s the answer when it comes to buying property through a company? Is it right for you?
The short answer has historically been “probably not” – the majority of investors have tended to operate as sole traders because it’s easier and usually more beneficial for them to do so. However, the changes to the treatment of mortgage interest announced in the Autumn 2015 statement are going to result in a lot more investors going down the limited company route in the future.
New investors could save themselves a large amount of tax by getting the ownership right. But is this the right route for you?
Are you a property trader or a property investor?
This is an important distinction to draw when making this decision:
If you buy a property in order to make value-adding improvements and sell on for a profit, you are a trader.
In this case you are likely to be better off buying as a limited company. This is because when you sell each property as a limited company you will pay corporation tax on your profits – currently 20%. If you bought a property to “flip” as an individual, your gains would be taxed as income – if you were a higher-rate taxpayer, this would be 40%.
(As an individual you might be able to get the profit treated as a Capital Gain rather than income if you could prove that you intended to rent the property out, and maybe did for a short time before selling it, but this could be contested by HMRC).
If you buy a property to rent out and intend to keep it for a number of years, seeing the value of the property increase over time, you are an investor.
In this scenario there is no clear answer - “it depends”! Most investors operate as sole traders, but some would benefit greatly from using a limited company.
Why might investors want to use a limited company?
Purely from a financial perspective, there are three obvious reasons why you might want to hold property as a company rather than as a sole trader.
1. Tax treatment of profits
If you own a property in your own name, the profits you make from renting it out will be added to your other earnings (such as from your job) and taxed as income tax. But if you hold it within a company, the profits will be liable for Corporation Tax instead.
The rate of Corporation Tax is currently 20% (if your profits are below £300,000), which means your tax liability is halved compared to if you’re paying income tax at a rate of 40% or higher.
You will still be taxed on the dividends if you take profits out of the company, but there’s flexibility: you can time your dividend payouts for maximum tax-efficiency, or distribute them to family members who are only basic rate taxpayers – or just leave the profits rolling up within the company to buy the next property.
2. Tax treatment of mortgage interest
As of April 2020, mortgage interest will no longer be an allowable expense for individual property investors (they’ll claim a basic rate allowance instead) – but it will continue to be allowable for companies that hold property. The change is being phased in from April 2017. Details of this can be found in our post on the changes to the taxation of buy-to-let properties
The upshot of these tax changes is that if you pay tax at the higher rate and you use mortgages to buy property, your tax bill will be higher if you own property in your own name rather than as a company.
3. Chance to mitigate inheritance tax
With property held within a company - if you know how - you can pass the property on to your children without them having to pay any Inheritance Tax. As a property investor, business property relief (which means Inheritance Tax does not apply to the sale of business property) isn’t normally available to you, but by structuring your company cleverly - such as using an employee ownership trust - this is possible.
Despite these tax advantages there are downsides to investing through a limited company.
Why not invest through a limited company?
The biggest drawback when it comes to using a limited company to invest in property is to do with lending. Most normal buy-to-let lenders won’t lend to limited companies at all. Some may do if they are given a personal guarantee by the directors, but for the most part the only option for a company is going to be using commercial lenders – and these are harder to come by. The interest rates have tended to be higher and are often only on repayment rather than interest only terms. The loan to value ratios are often smaller too.
There are other drawbacks, such as the extra expense and the hassle of filing annual company accounts, but access to finance really is by far the biggest reason not to invest using a limited company.
However, given the rush of investors into limited companies which is likely to take place over the next few years, we can see buy-to-let lenders responding by opening up their product range to limited companies – albeit still requiring personal guarantees, and with rates and fees being somewhat higher.
How to decide if using a limited company is right for you
Which side of the fence you come down on when it comes to buying through a limited company is going to largely depend on three factors:
How much income do you have?
If you’re paying income tax at 40% or higher, and you don’t have a lower-earning spouse whose name the property income could be put into, the lure of paying 20% Corporation Tax rather than 40%+ income tax is going to be strong.
However, do bear in mind that if you’re actively acquiring properties your portfolio could be generating a paper tax loss rather than a profit – so with planning, taxable gains could be delayed until you retire and your income falls.
Do you use mortgages?
The ability to claim the entirety of your mortgage interest as operating expenses (once the new rules take hold) will be a major argument for using a company for higher-rate taxpayers.
How much cash do you have access to?
Because mortgage options for companies are restricted, using a company is more likely to be right for you if you can buy in cash or borrow at lower loan-to-value ratios. As a result you won’t be getting the very highest return on your cash (because it won’t be compounded by the use of leverage), but you will still be benefiting from the rental income and capital growth over time.
Who are you buying properties for?
Initially of course it’s yourself, but what is your exit strategy? Do you plan to sell them off to finance your expensive cruise habit in your later years? Or is it important that you pass your portfolio on to your children or grandchildren?
If passing your properties on is important to you, holding them within a company (if structured correctly) could result in huge Inheritance Tax savings.
So the answer is, of course…”it depends”
There are clearly a lot of different factors in play here so you need to realise that compromise is inevitable, and weigh up all the pros and cons before deciding which side of the fence to come down on.
The most important piece of advice is this: Speak to DMF Accountancy Ltd to help you make the right decision for you.