The pros and cons of personal versus corporate ownership of buy-to-let property and how the position has been affected by the recently announced changes to corporation tax and income tax rates.
While the Chancellor’s Growth Plan (and subsequent U-turn on the abolition of the additional rate of tax) may have inadvertently sparked a (temporary?) hike in interest rates, it’s not all bad news for buy-to-let property owners and investors who don’t need to borrow to finance their property investments.
The increase in the nil rate threshold for Stamp Duty Land Tax (SDLT) to £250,000 benefits not only those replacing their main residence, but also carries through to purchasers of additional residential property who pay SDLT at the standard residential rates plus a 3% surcharge. This is because the extension of the nil rate threshold also extends the 3% rate threshold. This will deliver a £2,500 SDLT saving on new purchases of additional residential property worth at least £250,000 completing on or after 23 September.
Property investors who are buying property via (or thinking of transferring existing residential property to) a company will also benefit from this SDLT saving and this may increase interest in using companies to hold property investments – especially as the planned increase in the corporation tax rate (from 19% to 25%) – which would have affected companies with profits (net annual rental income) of more than £50,000 – has now been reversed.
An ‘accumulation-stage’ investor who is still buying property and building their portfolio may also be in a position to make a loan to their company to fund the property purchase which would pave the way for tax-efficient extraction of accumulated rental profit at a future date; but where the property investor has already amassed a substantial personally-owned property portfolio there are a whole host of “tax factors” that need to be considered before deciding whether to transfer to a company or to retain the properties in individual ownership.
Main considerations on transferring existing properties to a company
Assuming that the properties are not mortgaged (mortgages can create other complexities) the main considerations will be capital gains tax (CGT) and SDLT.
The transfer of one or more properties to a company will be a disposal for CGT and the property owner will therefore usually need to pay CGT on the difference between the market value at the time of the transfer and the acquisition cost of the property, unless incorporation relief can be claimed.
Incorporation relief can be claimed to defer the payment of CGT only if all of the conditions of s162 Taxation of Chargeable Gains Act 1992 are satisfied – including the need for the individual to be operating as a business. HMRC will generally accept this to be the case if the property owner is dedicating around 20 hours a week of personal time to the management of the property letting, but this is often going to be difficult – especially if the owners are past retirement age and winding down or the property investor has a full-time job.
Where residential property is transferred to a connected company, SDLT will also be payable by the acquiring company on the market value of the property at the time of transfer at the higher rates applicable to purchasers of additional properties (although multiple dwellings relief may be available to reduce the charge if more than two properties are transferred in the same transaction). While the SDLT bill is now, as we have already noted, going to be marginally less than it would have been for transactions completing prior to 23 September, let’s not forget that the individual may have already paid SDLT on the purchase price at the higher rates when they bought the property.
An exemption from the SDLT charge on incorporation is available where the transfer is made from a partnership to a company owned by the same individuals. However, the partnership must be a genuine partnership that is registered with HMRC and that has subsisted for a reasonable amount of time. Joint ownership, in itself, is insufficient and HMRC may seek to challenge claims for relief in cases where the partnership has been in existence for only a short period (as a ‘rule of thumb’ less than three years) and/or there seems to be no other genuine commercial reasons for establishing the partnership.
But that aside….
Where SDLT and CGT costs can be mitigated or are not prohibitive, transferring property into corporate ownership can provide considerable tax benefits to those who wish to build up a portfolio of properties over time and use it to generate income in later life. This is largely due to the fact that the company will pay corporation tax at just 19% on rental income net of deductible expenses (including mortgage interest) as compared to the 40%/45% rate of income tax that could be payable on the rental profits if the property was held personally. As a consequence, where the taxed income is saved and reinvested in further properties, the company will be able to build the portfolio much more quickly than an individual investor could do – and the additional income that a larger portfolio will generate will provide an overall higher net return for the client in retirement, even after allowing for the extra tax at shareholder level. The reinvestment of the additional net income receivable through using a company over time may also eventually produce a sufficiently improved position to compensate for the disadvantages of realising residential property gains within a company structure and suffering a second layer of tax when extracting the net sale proceeds.
It is, however, important to appreciate that the company route will rarely be beneficial if the property investor is planning to extract the company rental profits. Not only will the investor lose out on the compensatory portfolio growth that accumulation and reinvestment within the corporate wrapper will bring, (unless they have made a loan to the company to finance the property purchase), the profit will usually need to be extracted in the form of a dividend, meaning that there is going to be additional tax at shareholder level. While this will improve post 6 April 2023 (when the tax rates on dividend income will fall) this element of double taxation still means that the client who intends to extract all the rental profit from the company as a dividend will often be better off keeping the properties in individual ownership.
What about inheritance tax?
Shares in a property investment company don’t tend to qualify for the reliefs available in respect of shares in trading companies so the value of these shares will form part of the client’s taxable estate for inheritance tax (IHT) purposes unless they give them away during their lifetime. The value of the shareholding will broadly reflect the value of the company’s net assets (so a shareholder who has also made a loan to the company – and has an outstanding amount as an asset of their estate – won’t be taxed twice).
Of course, as the properties grow in value, so will the value of the investor’s shareholding but, fortunately, estate planning with company shares is a lot easier than estate planning with property. A gift of shares, if made outright, will be a potentially exempt transfer (PET) which means that an immediate liability to IHT will never arise regardless of how much value is gifted at once. And if the gifted shares don’t carry voting rights, the PET can be made without necessarily giving the recipient immediate access to the underlying value. It should be remembered that a gift of shares will also be a disposal for CGT purposes, but as long as any planned gifts are made shortly after incorporation, any gain should be covered by the shareholder’s annual exemption.
It will be clear that there are a lot of different factors to bear in mind when considering whether to hold property investments personally or within a company structure but, in summary, the company ownership approach tends to work best with new properties (or existing properties where SDLT and CGT can be mitigated or deferred) and where the client isn’t likely to need to start withdrawing the rental income for many years. An exception to this rule might be where the property investor is a higher rate taxpayer with significant finance costs – in these cases using a property investment company can sometimes yield savings even if the higher rate taxpaying residential property investor is extracting all their company’s after-tax profits. This is because, unlike individuals, a company is still able to deduct mortgage interest from gross rental income in order to arrive at their taxable profit.
There are also other factors specific to the individual client circumstances and objectives that could swing the balance one way or the other and it will therefore be vital for the client to take independent tax advice before making a decision or pursuing any particular course of action.