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Moving buy-to-let properties into a company - issues to consider

Contractors who also receive income through rental properties may want to consider setting up a company to mitigate the impact of changes to the taxation of buy-to-let properties, but only if their income reaches a certain threshold.

Contractors – as well as large scale residential investors – are now subject to the 3% stamp duty land tax (SDLT) hike on the purchase of buy-to-let properties, which came into play on 6 April 2016.

From 2017, buy-to-let landlords will also be restricted on the amount of mortgage interest they can declare as a deduction from their rental profits. This has prompted several experts to suggest that contractors consider incorporating their rental income to mitigate their impact.

However, owner and head of tax at contractor accountant Abbott Moore James Abbott warns that whilst there are obvious advantages to having a property within a company, there are plenty of other factors to consider.

Buy-to-let landlords risk excessive tax hike

“The concern is that buy-to-let landlords will be taxed on a higher profit than they have actually made,” explains Abbott. Whilst currently a business would pay tax on the difference between profits and expenditure, buy-to-let landlords will only receive a deduction on a portion of their interest costs.

As Abbott explains, this looks set to sting a large portion of contractors with lower value buy-to-let properties who unfortunately have no other option.

“Where you have rental profits that are in single-figure thousands, it’s probably not going to be worth setting up another company. The administration costs and everything else involved would simply outweigh the benefits of incorporating.”

Abbott adds that, unless the contractor already has a large buy-to-let portfolio where they spend a large proportion of their time and can therefore holdover the gain, the likelihood is they will have to pay capital gains tax (CGT) when transferring an existing property portfolio from personal to company ownership.

“Say you bought a property for £100,000 and it is now worth £150,000 – if you wanted to put it into a limited company you would have to pay CGT at a rate of 18%-28% on the £50,000 increase, although most individuals will have their CGT Annual Exemption of £11,100 (2016/17) available. So, whilst in reality you own the company that then owns the property, that’s money you’re going to have to find.”

Contractors urged not to combine contracting and rental income

For contractors who receive sufficient rental income to justify incorporating - and who aren’t deterred by the prospect of CGT – setting up a new limited company is easily the most viable option. Otherwise, as Abbott notes, peculiarities with the flat rate scheme that many contractors adopt can result in extra taxation on rental income.

“Contractors would naturally consider letting their properties through their existing limited company. For example, you use cash reserves in your contracting company to invest in property. The biggest headache with this is, the flat rate scheme that most contractors use requires them to pay their flat rate percentage not only on income that VAT is charged on, but also things that are exempt from VAT.”

Rent falls under the latter category, but contractors would still be required to declare their normal flat rate - say 14.5% - to HMRC on the rent received. To avoid this, contractors are strongly advised to set up a separate company, which Abbott acknowledges is as straightforward as opening an initial limited company.

Transferring mortgages is a no-go

One problem posed by opening a new company is the obvious lack of funds to buy a property to begin with. Fortunately, contractors are usually able to transfer money from one company to another without any issues.

“However, the key thing is limited companies aren’t necessarily the answer for all landlords,” Abbott adds. “You have to be doing enough to the point where the new rules are having such a financial impact that it makes running a limited company worth your while.”

Abbott also notes that any money transferred into a buy-to-let company tends to need to belong to the contractor. Attempting to use money obtained via a personal mortgage to purchase buy-to-let properties to a limited company account poses impracticalities with getting tax relief in itself.

“When you have a buy-to-let in place, you’ve obviously borrowed money and agreed something with a mortgage provider - mainly that the property will remain in your personal name. But that agreement has been made with you personally, and so it’s not always easy to get the mortgage transferred to the limited company.”

Abbott does concede that there are now more providers willing to provide mortgages for companies looking to buy-to-let. There are also potentially ways that contractors can set deeds of trust that may enable them to transfer personally owned properties into the company’s name, but such processes are often very complicated.

Contractors advised to weigh up the pros and cons

One of the main advantages of opening a limited company is that, for higher rate taxpayers, the rent is only taxed at 20%. There is also no personal tax to pay if the contractor chooses to keep the profits in the company.

However, contractors who do decide to withdraw money from the company are warned that it will be subject to the recently ramped-up dividend and personal tax rates.

“When it comes to selling a rental property, an individual would pay anything between 18% and 28% on anything above their annual exemption for CGT– which is roughly £11,000 each year,” Abbott adds.

If the contractor were to do the same through a company, the company would pay 20% corporation tax on the capital gain, but would also potentially have to pay personal tax upon withdrawing the money.

“There’s effectively a double tax charge,” concludes Abbott. “So we say that letting properties through limited companies tends to be better from a tax and rent point of view, but you tend to pay more tax overall on the capital appreciation of the property itself. Ultimately, it’s up to the landlord to weigh up whether or not it works for them.”

Published: 25 May 2016

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