As a landlord, mortgage interest is probably the single biggest expense that can eat into a large chunk of your rental income. So in summer 2015 when the chancellor announced changes to mortgage interest relief for buy-to-let landlords, there has been a surge in the transfer of properties into a limited company. How attractive is this move? And will some landlords be jumping from the frying pan to the fire?
Let’s first recap of the new rules which came into effect in April 2017.
Landlords will no longer be able to deduct all of their finance costs from their property income. From 2020, you will instead receive a basic rate reduction from your income tax liability for your finance costs. So if you incur £1,000 interest, you will only be able to claim £200 (20 per cent x £1,000) off your tax bill.
But these new rules are being phased in. From April 2017 to March 2018 the deduction from property income will be restricted to 75 per cent of finance costs, with the remaining 25 per cent being available as a basic rate tax reduction. In 2018 to 2019, 50 per cent finance costs deduction and 50 per cent given as a basic rate tax reduction. And then in 2019 to 2020, 25 per cent finance costs restriction and 75 per cent given as a basic rate tax reduction.
However, this change doesn‘t apply to limited companies so many buy-to-let landlords are now tempted to transfer their property into a limited company to continue claiming tax relief on all the interest and finance costs.
But is this a good idea?
Certainly it seems a good plan to form a limited company, transfer the buy-to-let property into the company and continue enjoying the tax relief. The other benefit is that the any net profit will be taxed at the lower company tax rates of 20 per cent. And also you get all the other benefits of operating a limited company including credibility and limited liability. So far so good right…?
Well not quite. You may find yourself landed with unnecessary tax bills and costs. So, here are five common pitfalls that landlords should be aware of:
Stamp Duty Land Tax
If you transfer the property from yourself to the company (effectively the company buys the property) then the company could easily become liable to pay stamp duty land tax. So whilst you’re trying to reduce income tax, you can wind up paying the same amount or more in stamp duty land tax if you’re not careful.
Capital Gains Tax
If you transfer the property to the company, you will be treated as if you’ve sold the property to the company. If the property has gone up in value since you originally bought it, you’ll have to pay up to 28 per cent capital gains tax on the difference, subject to any tax reliefs and allowances. If you have a few properties to transfer, seek advice about a relief you could claim to defer your capital gains tax.
These two main tax pitfalls could potentially wipe out any short term savings you get through mortgage interest relief in the company you’ve formed.
Because you‘re transferring the property from yourself to a company, the company may not get the same mortgage rate that you‘re currently on – in most cases the interest rate is higher for commercial or company mortgages than it is for individuals. So do take extra care because this additional bank charge will increase your costs over the full term of the mortgage.
Once the property is in a limited company, it is owned by the company, not the landlord. From a commercial point of view, this leaves the property exposed. If something happens to the company, all its assets will be exposed including the property that you put in it.
Selling in the future
What if you wish to sell the property in the future? A company will be paying 20 per cent corporation tax on the profit it makes. When you sell the property, the money from the sale will go into the company. The company will pay Corporation Tax on the profits and the balance of the money from the sale will remain in the company.
In order to get access to the funds to enjoy you’d need to take it out of the company either as salary or dividends or other means. You’d then pay additional tax on that income. When you take the above into account the idea of transferring your buy-to-let property into a limited company starts to sound rather bleak.
But there are some situations where you can reduce or eliminate the pitfalls above and enjoy some of the benefits of holding your properties through a limited company.
If you’re buying a new property then a limited company could be a good idea
But if it’s an existing property and you’re only managing one or two properties, I’d say: don’t bother. You’re better off paying just a little bit of tax now instead of triggering all these taxes and then having to pay additional double tax if you sell the property in the future.
If you currently run your buy-to-let through a properly arranged partnership business, then transferring into a limited company could be a good idea because some of the tax burdens above could be reduced.
Landlords who want to leave their buy-to-let properties to their children could consider the pros and cons of a Family Investment Company as an alternative to a Trust.
Clearly the message here is; don’t rush into it. It’s extremely unwise to move buy-to-let properties into a company without taking professional advice. Whilst there’s no simple answer to the question and it all depends on your circumstances, as a general ‘rule of thumb’ I would say that if it‘s only one or two existing properties in your name, it‘s not a good idea.
If you‘ve got six-ten properties, it‘ might be worth your while to look at how you can enjoy the benefits of a limited company without triggering unnecessary taxes and costs.
Jonathan Amponsah is founder and CEO of The Tax Guys