Since 2017, the number of limited companies established by landlords holding properties has tripled, with 300,000 being recorded in 2022. It is believed that 40% of all new buy-to-let acquisitions are now made using a company structure, with record numbers of landlords choosing to set up a limited company.
This change of legal entity for many landlords was caused by adjustments to the tax relief scheme announced in 2015, known as Section 24, which changed how landlords’ income was taxed.
This article explores why personal landlords have begun to own homes as a limited company, as well as the advantages and disadvantages of this choice.
What is Section 24, and how does it affect landlords?
The tax relief scheme underwent significant revisions in 2020. This reform, known as Section 24, implies that landlords must now pay taxes on all rental income from their buy-to-let properties. Before this, they could deduct their mortgage interest and other expenses from rental income and only pay taxes on the profit from property held.
Landlords can still claim back some mortgage interest charges under the new system, but this is now limited to the basic 20% rate of income tax.
Since the announcement, a significant number of landlords have formed limited companies in order to handle their tax obligations; however, should this be the case for all landlords?
We’ve highlighted some of the main advantages and disadvantages, but we always recommend that people seek independent financial advice before making any changes to their buy-to-let properties.
The Advantages of Having a Limited Company
Lower tax bill
Taxation is the primary driver of this change to limited company form. When the properties are owned by a limited company, the landlord, who is now a director, pays no income tax on the rental proceeds, thus enjoying tax benefits. Instead, the company pays 25% corporation tax.
If landlords were previously 40% tax payers, they will now pay much less tax as a limited company subject to corporation tax.
Liability is limited
In a limited company, the business’s finances are separate from those of the individuals. The property portfolio is owned by the company rather than the landlord, so creditors cannot simply claim it.
Increased profit flexibility
The profits from rental income can be used more freely within a company framework. Before paying income tax, it can be reinvested to purchase additional buy-to-let properties and build a portfolio. It can be invested in pension plans, used to pay off obligations, or distributed as dividends to take advantage of tax breaks.
Inheritance Tax and Change of Ownership
As a limited company, it is much easier to change ownership of the company and consequently, the portfolio of buy-to-let properties than it is for an individual landlord. The company keeps ownership of the properties, which may be protected from stamp duty, inheritance tax, and capital gains tax responsibilities.
The Potential Failures of Building a Company Structure
Not tax efficient for lower-income taxpayers
Landlords who own only one property or who are only subject to the basic income tax rate are far less affected by Section 24, and forming a limited company is most likely not going to be a tax-efficient move.
However, if a landlord’s profit or other salaried income rises and pushes them into the higher tax bracket, it may be time to reconsider if a limited company is more cost-efficient.
Properties Must Be Sold to The Limited Company
Any properties currently owned by the landlord would have to be sold to the company. In doing so, stamp duty would be imposed. As a result, many landlords continue to own their present properties while expanding their portfolio by purchasing new ones through the corporation.
Running a company entails additional responsibilities
Directors of a limited company face more legal and financial obligations than personal landlords. Companies House and HMRC will require extensive financial records as well as tax returns. Many companies pay for an accountant, which can cost up to £1,000 per year.
Double Taxation Concerns
A limited company pays corporation tax on profits, but directors must pay income tax on salaries and dividends.
The capital gains tax allowance is not included
When selling your property as an individual landlord, you must pay capital gains tax, however, there is a tax-free exemption. This is currently priced at £6000.
When a property is sold through a limited company, there is no tax-free allowance; however, the rate is lower, and there are additional tax efficiencies gained by being a limited company, which may balance the lack of free allowance.
Mortgages are more costly for limited companies
Mortgage fees and interest rates may be greater for a limited company than an individual buying-to-let property. Buy-to-let mortgage terms may also be more complex, with fewer loan options available.
It’s Not Always Easy to Release Equity
You as a landlord have the option to release equity from a property and keep the money for yourself. Although those funds can still be issued in a limited company, they will need to be treated as income and subject to taxes if they are intended for the directors.
What Steps Should You Take Next?
When choosing to become a limited company, there are a lot of factors to consider. However, it could be worthwhile to look into the pros and cons of your available choices, and get independent financial counsel if you are a landlord already in the higher income tax category.
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