Insights

Since the 2015 Budget and George Osborne’s shock announcement that mortgage tax relief would be restricted on rental properties, there have been many articles in the media discussing tax planning strategies for buy-to-let investors. Many of these suggest that it is now more tax efficient to transfer ownership of rental property to a company, primarily because of the lost tax relief. This advice could hold true, but as with everything in tax, it will very much depend on the individual circumstances.

Given that property is such a popular investment, we thought it would be helpful to include a blog about property and tax in this month’s Livewire. The situation with regard to property tax has become significantly more complex in recent years and as a result there is an even greater need to take specialist advice in order to fully appreciate the pros and cons of a particular tax planning strategy.

Quick situational recap – removal of mortgage tax relief and wear and tear allowance

HMRC requires taxpayers in receipt of property rental income to declare all profits on their annual self assessment tax return. Profits are calculated by subtracting allowable tax-deductible expenses from rental income. Currently, mortgage interest can be deducted in full to reduce the final profit level, with higher rate tax payers of course gaining tax relief at the higher rate.

Starting from April 2017, the rate of tax at which mortgage interest can be relieved will reduce, reaching a minimum level of 20% with effect from April 2020. Clearly this will impact higher rate taxpayers and most specifically those who are heavily geared with a large property portfolio.

In addition, landlords of furnished properties are currently able to deduct a flat rate of 10% each year to cover the wear and tear of the property’s furnishings, regardless of expenditure in the year. This allowance is also being removed and from April 2016 landlords will be able to deduct the cost of replacement furnishings. These changes are explained in full in our earlier blog.

Although the removal of the wear and tear allowance affects all landlords, the reduction in the rate of relief for mortgage interest affects only higher rate taxpayers; hence it does not affect limited companies. It is therefore easy to see why there are suggestions that company ownership may be preferable; the company only pays corporation tax at the rate of 20% on profits, and relief for mortgage interest is also given at the rate of 20%.

Whilst this may indeed be the answer going forward, there are additional issues to be considered:

The shareholders are also able to remaining profits as dividends, although the amount of tax they will incur is also set to increase, again as a result of the recent Budget. On the surface, it would appear that company ownership is preferable; however there are some important caveats.

1. Can you get a decent mortgage?

Buying a property through a limited company will restrict the number of willing lenders; commercial mortgages are available, but typically these mortgages have higher interest rates.

2. The cost of extracting funds from the company

Although the company suffers tax at the rate of 20% only, additional tax liabilities arise if funds are taken from the company, typically as dividends by the shareholders. Tax on dividends is set to increase with effect from April 2016.

3. The cost of transferring personally owned property into a company

If the rental property is already owned personally, transferring it to company ownership will trigger a capital gains tax liability, and stamp duty land tax. This is because the property will effectively be sold by the owner and re-purchased by the company. If the owner is a higher rate taxpayer, capital gains tax will be charged at 28%, which could represent a significant tax liability, especially given the rate at which property prices have risen in recent years.

4. ATED - Annual Tax on Enveloped Dwellings could be payable

This is a charge on high value residential properties which are owned by companies. Initially, ATED was charged on properties worth £2m and above. Since its introduction, this level has decreased and from 2016, it will be payable on property worth £500,000 at a rate of £3,500 per year, thus impacting many landlords with a London portfolio. Our earlier blog outlining the impact of ATED explains the likely costs of this additional tax.

5. Stamp Duty Land Tax

Depending on the value of residential property, the amount of stamp duty land tax (SDLT) payable can increase significantly when the property is purchased through a company. Properties costing £500,000 or more attract SDLT at the rate 15%, whereas the rate for privately owned residential property is 5% up to a value of £925,000. Full details of changes to stamp duty are covered in our earlier blog.

This summary of the various issues to consider highlights the many caveats to be aware of when considering whether it would be more tax efficient to own a rental property through a company. It’s clearly more complex (and costly) from an accounting perspective and might not necessarily save money in the long run. A case by case approach is essential, especially given the complexity of tax legislation in this area now. If you would like to discuss property tax planning in more detail, please contact Lesley Stalker by emailing las@rjp.co.uk.