The UK property market has undergone significant changes in recent years and there has been an influx of property investors buying property through a limited company. This is particularly after the introduction of Section 24 Finance (No.2) Act of April 2017.
Section 24 is legislation which prescribes that private landlords can no longer offset their mortgage costs as an allowable expense against their business. Section 24 is however, not applicable to limited companies. But what about if you already own property as an individual? Is it worth transferring the ownership to a limited company?
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Why are people switching property ownership to limited companies?
Owning property through a limited company can offer multiple tax savings, especially if you are a higher-rate or additional-rate taxpayer. However, it may not be as beneficial if you fall into the basic rate tax bracket. It’s usually advised that you purchase the property from the start through a limited company as it can be costly to transfer ownership later down the line. However, if you do want to transfer ownership it can still be worthwhile in the long term.
The reasons why owning property through a limited company is more tax-efficient include:
1. Corporation tax vs income tax:
One of the most notable attractions to transferring property to a limited company is that it may be beneficial to those who are in the higher or additional income tax brackets when you compare income tax vs corporation tax. Limited companies are subject to corporation tax instead of income tax on their earnings.
Corporation tax is charged at 25% or you can be eligible for the lower 19% rate if you fall within the Small Profits Rate (companies with profits of £50,000 or less).The difference may not be highly significant for someone who falls into the basic income tax bracket of 20%, but for landlords who fall into the higher or additional rate bracket of income tax (40% or 45% respectively) it can mean a high reduction in tax liability.
2. Section 24 legislation does not apply to Limited companies:
With the introduction of section 24 legislation which was introduced in 2017, private landlords are no longer able to claim the cost of mortgage interest as a tax-deductible expense and instead can only claim tax credits which are for 20% of the mortgage cost. This means there are less allowable expenses to reduce their profits before tax is calculated and results in higher tax bills.
However, the legislation does not affect properties purchased through limited companies, making buying property through a limited company can be an attractive prospect for tax-saving purposes. Limited companies are able to claim 100% of the mortgage costs against profits, therefore reducing the amount of corporation tax that needs to be paid.
3. The most tax-efficient way to pay yourself as a director:
Owning property through a limited company means that you are entitled to receive a salary as a director. Your salary will be subject to income tax. However, you’ll also be a shareholder and so therefore entitled to dividends.
Receiving a combination of both incomes is a tax-efficient way to extract funds from your limited company for personal use. Dividends are taxed at a lower rate than income tax. What rate of dividend tax you pay is based on your income tax bracket, so, for basic rate income taxpayers, dividends are charged at 8.75%; higher rate taxpayers are charged 33.75% and additional rate taxpayers are charged 39.35%.
4. Dividing property ownership through shares:
Transferring property into a limited company can be beneficial if you want to share ownership between other people. This is particularly useful if you want to share ownership between more than 4 people because the maximum number of registered proprietors for property is 4. If your company is shared between members of your household, then you’ll be able to take advantage of each individual’s annual dividend tax allowance. You would be able to withdraw more dividends whilst paying less dividend tax than if you owned the company by yourself.
5. Using Business property relief to reduce inheritance tax:
An attractive prospect of transferring property ownership to a limited company is being eligible for business property relief. Business property relief allows the value of business assets to be reduced for inheritance tax purposes, therefore reducing the overall value of the estate and inheritance tax liability. There are complex rules to follow but the requirements are:
- To have been part of a business for more than two years before applying for business property relief.
- Not in the process of being wound up or sold within 1 year of death.
- The property is actively being used for at least 50% of business activities and isn’t being purely held as an investment property.
Business property relief will reduce the value of the property owned by the limited company to 50% before inheritance tax is charged at a rate of 40%.
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What are the fees you need to pay when switching property to a limited company?
When considering a property transfer to a limited company, you must factor in the various costs involved and evaluate them in depth before the transfer of any property.
Unfortunately, a fee you will encounter is having to pay stamp duty again and it will be based on the property’s current market value, rather than the usual calculation of the price of consideration (amount purchased for). You will also need to factor in the possibility of conveyancing fees for transferring property ownership and any commitments to existing mortgages you may have.
If you are planning to use a mortgage to pay for the property under the transfer of ownership you will need to be prepared that limited company mortgages can carry higher fees and can be harder to find. This is because limited companies carry a perceived higher risk of lending than to an individual, as well as being considered to be more niche. This means they can often attract higher interest rates when borrowing, as well as it can take longer to go through due to the more in-depth evaluation they are subject to.
Other things to consider before switching property ownership to a Limited company:
Other things to consider when switching property ownership over to a limited company are the added legal responsibilities that come with it, which can be time-consuming and a high responsibility.
You will have the legal tasks of filing annual accounts, company secretarial, submitting a yearly self-assessment tax return as well as paying corporation tax. Failing to comply with these legal requirements can result in penalties or legal actions. Therefore, it is important to make sure you are fully prepared to take on that responsibility before starting a limited company. Alternatively, you can outsource this to a professional, which is also a deductible business expense.
You should also consider your income tax threshold before the transfer of any property.
This is because transferring a property to a limited company may not be a tax-efficient option for basic-rate taxpayers as the main corporation tax rate is 25% or if your profits are under £50,000 then the small business corporation tax rate is 19%. Therefore, the added administrative and legal responsibilities may not be worth the small tax savings.
On the other hand, if you are a higher rate or additional rate taxpayer, transferring ownership of your property to a limited company can be highly beneficial. It can significantly reduce your tax bill. This option is also worth considering if you are planning to start a property business, as it offers more flexibility and tax advantages.
What tax relief is available if you want to switch property ownership to a limited company?
If you have a property that has increased in value since you bought it, you may have to pay capital gains tax (CGT). However, there is a way to offset this tax called Incorporation Relief. This relief allows you to roll over the gain into shares of the company and delay payment of CGT until the shares are sold. The best part is that if the company shares are never sold, CGT will be delayed indefinitely. This can be a great advantage for landlords who do not want to pay CGT, but there are stringent rules to qualify for this relief.
HMRC judges each case on a case-by-case basis, and to qualify, you must be a sole trader or in a business partnership and be able to prove that the property is part of a legitimate business before being eligible. You must also be the owner of the property or own it as a business partnership to be considered. Moreover, you must transfer all business properties as a going concern for shares within the limited company.
Any partial or full cash exchanges could disqualify you or be seen as only eligible for partial relief. Finally, there must be proven high active involvement from the landlord in the business management. Previous cases have been dismissed for investment properties outsourcing the management of the property to letting agents.
In conclusion, transferring property to a limited company can be tax-efficient, especially for those in a higher or additional tax bracket or if you are looking to start a property company. However, it is essential to consider the extra legal and regulatory obligations and the limited mortgage options.
It is important to evaluate the costs associated with transferring a property to a limited company and the many variables, including legal fees, stamp duty land tax, and CGT, before making a decision.
We advise you to seek professional advice from tax advisors and accountants to navigate the complexities of UK tax laws and ensure that this is a beneficial financial decision for you.