As income tax relief on finance costs for buy-to-let properties is being restricted, the question which now arises is – Is it becoming more beneficial to purchase personally or through a Limited Company?
From the 2020/21 tax year, if you own a buy-to-let property personally, you cannot deduct the finance costs from your property income when calculating your taxable profit. However, you will get a basic rate tax reduction on the finance costs from your income tax liability.
This measure came into effect for finance costs incurred on or after 6 April 2017.
This is such a game-changer for landlords, therefore the new regime is being phased in over four years on the following basis:
- Tax year 2017/18: You can deduct 75% of your finance costs from property income. The remaining 25% can be claimed as a basic rate reduction from your income tax liability.
- Tax year 2018/19: You can deduct 50% of your finance costs from property income. The remaining 50% can be claimed as a basic rate reduction from your income tax liability.
- Tax year 2019/20: You can deduct 25% of your finance costs from property income. The remaining 75% can be claimed as a basic rate reduction from your income tax liability.
- Tax year 2020/21: For all financing costs, you incur can be claimed as a basic rate reduction from your income tax liability.
How the figures will look?
Below is a very basic example to help you understand how this can impact your income tax liability.
If you are a higher rate taxpayer, paying tax at 40% and owns a property paying monthly mortgage interest of £600 and receiving £1,100 monthly rental.
Pre 6th April 2017
Post 6th April 2020
Rental income: £13,200 per annum
Mortgage Interest: (£7,200)
Taxable profit: £6,000
Income tax (40%): £2,400
Rental Income: £13,200
Mortgage Interest: 0
Taxable profit: £13,200
Income tax (40%): £5,280
Basic rate tax relief on mortgage interest £7,200 X 20%: (£1,440)
Net tax payable: £3,840
£1,440 or 60%
Buying a buy-to-let property via an SPV limited company, rather than as an individual, has recently become more popular mainly due to the above changes.
As per the recent research, one in five rental properties are now owned by a corporate landlord. It has become even more pronounced in the capital with more than a quarter of rental homes in London are owned by company landlords.
Making new purchases under SPV Limited Company.
A further option for buy-to-let landlords is to purchase the property by using an SPV limited company with the investor(s) being company directors and shareholders of the company.
An immediate advantage of this route is that presently, limited companies are able to offset all of the mortgage interest against profits from the rental income. The subsequent profits are then subject to Corporation Tax, currently at 19% but expected to reduce to 17% by the 2020/2021 tax year.
Transferring buy-to-let property into an SPV Limited Company;
If you have an existing portfolio, it is possible to transfer ownership of the property to an SPV Limited company.
Any transfer will be deemed at the market value of the property at the time of transfer which may mean additional costs such as capital gains tax, stamp duty, and the legal, mortgage and valuation fees.
It is also important to note that limited companies do have running costs and legal requirements such as filing statutory accounts. However, you will gain the advantage of tax-deductible expenses such as mortgage broker fees, lender arrangement fees, and accountancy fees.
Now the question arises, how to draw money from the company? Funds can be taken in the way of salary and/or dividends:
It may be advantageous to pay a salary up to the National Insurance threshold of £8,424 in 18/19.
Any salary paid is an allowable expense against the profits of the limited company.
Dividends are paid from profit left in the business after paying any corporation tax liability. As tax has already been paid by the limited company on the profits, a further Dividend Tax is payable by the recipient shareholder(s) on any dividends received after a £2,000 (for 2018/19) tax-free allowance has been used up. The rate of Dividend Tax will be dependent upon the total income of the shareholder.
If landlords don’t need the income for current personal expenditure at the time, the retained funds can be used to reinvest in further property ownership for the limited company as opportunities arise.
Careful planning is therefore required as the initial cost in transferring a buy-to-let property to a company may outweigh any benefits in the short term. The mortgage interest restriction is taking 4 years to reduce to basic rate tax relief only, so landlords do have time to plan.
New buy-to-let property purchases might, however, be more beneficial for tax purposes to be put directly into a company if the plan is to hold the property for the long term.
If the rental income is required for day-to-day living, you will need to consider how the income will be extracted from the company. This may negate some or all of the tax savings you made by putting the buy-to-let property into a company in the first place.
It is also worth considering that a company will pay Corporation Tax on the gain if and when a property is sold. As an individual, you have a Capital Gains tax-free allowance (known as the Annual Exemption) of £11,700 for 2018/19.
How can Gorilla help?
It is therefore essential that tax advice is sought before rushing into setting up a property company. Gorilla offers an accountancy service for landlords that operate either through a limited company or own the property personal and can provide tailored tax advice around your specific circumstances.