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limited company or sole trader

Over the last few years, we’ve seen a surge of investors choosing to set up limited companies for their buy-to-let investments. It used to be that this was the minority. However, with changes to regulations such as the changes to the mortgage tax relief scheme,  it has become increasingly hard to make profits as a landlord and as such, the number of landlords applying for limited companies has grown substantially.

The main reasons to set up a limited company for your buy to let investments are twofold. The first is it allows you to claim your mortgage or loan interest as an allowable expense, this is an allowable expense that has been phased out for personal investors over the last few years.

Additionally, it means you pay corporation tax, which is currently 20%, rather than income tax, which could be up to 45% depending on the tax bracket that you’re in.

With these two advantages on the table, it almost seems like a no-brainer. However, it’s not as simple as that. And before you contact your accountant or start registering with the Companies House there are a few things that you need to think about.

The Advantages of Using a Limited Company To Purchase Buy to Let

Tax Relief

As we’ve already mentioned, the UK Government phased out the ability for landlords to deduct interest payments as an allowable expense. Instead, individual landlords can claim back only a small portion of their interest payments.

This makes the total income that they need to report much higher and can cause people to slip into higher tax brackets. Currently, individual investors can only claim back 20% of their total interest payments,

Pay corporation tax, rather than income tax.

The rate of corporation tax in 2021 is 20%. This means that your tax liability may be dramatically reduced compared to if you’re paying income tax on your rental income. If you are a higher tax higher rate taxpayer, your income tax could be as high as 45%.

And with funds being retained in the limited company you can control how much income is taken personally, and therefore reducing the potential income tax liability, and avoiding being pushed into a higher tax bracket.

You can pay out tax-free dividends under a certain amount

Instead of taking a personal allowance, you can pay shareholders of your limited company, a tax-free dividend. The dividend tax credit was replaced in April 2016 with a tax-free dividend allowance. For the tax year of 2021/22 the dividend allowance is £2,000.

How much tax you pay on dividends above the dividend allowance depends on your Income Tax band.

Tax band Tax rate on dividends over the allowance
Basic rate 7.5%
Higher rate 32.5%
Additional rate 38.1%

The above chart is for the tax year 2021/22. The government plans on increasing this tax rate.

By retaining funds within the limited company you won’t need to pay income tax on those profits and instead, you can take those profits and reinvest them within the limited company, and in that way scale your buy to let portfolio more quickly.

Easier change of ownership

To change the ownership of a property held under a limited company you need to assign new company directors or shareholders. Doing this is much easier than a change of ownership of privately held property.

This can also be a strategy that you might use to avoid inheritance tax. Instead of passing on the property you can name heirs as shareholders or directors, and pass over the ownership of the company, rather than the properties themselves.

Additional privacy

The limited company’s name will be on the land registry documents rather than your personal names. This means if debtors attempt to hold you liable for tenant debts that you can’t be held personally responsible, and this won’t leave a mark on your credit file.

Reinvest company profits

You may be able to grow your BTL portfolio more quickly within a Limited Company as there will be no income tax on the retained profit, meaning more cash to re-invest.

The Disadvantages of Using a Limited Company For Buy To Lets

No capital gains tax allowance

For personal property, there is a capital gains tax-free allowance of £12,300 for the tax year 2021/22.

When a company sells a property on the other hand there is no capital gains tax allowance, meaning, capital gains will have to be paid on the entirety of the profit.

Property transfer costs

To transfer an existing property into the company name you will need to go through a transaction process in which you sell the property to the company. This process incurs a stamp duty land tax, legal costs, higher rates, and potentially even capital gains tax.

Because of this, it’s not generally advised to transfer properties you already own into a limited company. If you do intend to, it’s a good idea to do a thorough cost-benefit analysis with a specialist financial advisor in order to check the potential savings versus the incurred costs.

More administrative tasks

Setting up and running a company comes with more paperwork than investing as a personal investor or sole trader, you have to deal with the HMRC, complete annual returns and company accounts. And you will most definitely need a good accountant to help you meet regulatory company requirements. If you’ve only got one or two properties, all of the extra paperwork and costs associated with the additional admin may simply not be worth it.

Less lender choice

Most lenders and mortgage suppliers are happy to lend for buy to let investments in your personal name. However, the majority of lenders don’t offer limited company buy to let mortgages. This means that you have a reduced selection of lenders to choose from making it harder to secure a loan for your investments.

As a side-effect of this limited choice, you may also get offered a worse interest rate. These higher mortgage costs could very quickly.

Increased legal costs

Running a limited company comes with additional service and legal costs for things such as ensuring money laundering regulations are met, and that the company and mortgage are registered properly with the Companies House.

Harder to release equity

One of the main benefits of investing in buy to let’s is the ability to build equity in an appreciating asset. This equity can then be released through refinancing options at a later date to be used elsewhere or reinvested in additional properties.

This is a much harder thing to do when the buy to let is held in a limited company. Instead, the equity is effectively locked in. If you want to take the equity to use personally this will be classed as income and taxed appropriately.

Drawing Income From a Limited Company

One of the main drawbacks to trading as a buy-to-let investor through a limited company is that you may find it more complex to access funds. It is wise to consider in advance how the profits will be paid.

For example:

  • You could pay a salary from the company to the directors. Income tax will need to be paid at this point negating any positive effects of reducing income tax liability. However, you can at least keep control over the amount paid to ensure you stay in a lower tax bracket.
  • The company could declare dividends at year-end payable to the shareholders.
  • You could make pension contributions from the business on behalf of the directors.

Which of these options is most advantageous for you depends on multiple factors. If you do not have another significant income stream, paying a salary can be an attractive option.

Influencing Factors When Considering Whether To Purchase A Buy To Let With A Limited Company

You have to consider all of the factors listed above when considering which is the right investment structure for you. The purpose of setting up your portfolio under a limited company is to reduce your overall costs by mitigating your tax liability. However, the extra work and additional costs that are associated with setting up a limited company as well as the drawbacks of locking funds into the company mean this isn’t so straightforward.

Here are a few of the important factors to consider when calculating which option is the most tax-efficient solution:

  • How long you intend to retain the property – are you planning to redevelop and resell, or keep your property as a long-term buy-to-let?
  • What sort of income can you expect to generate regularly, and how you will leverage this revenue to support your investment portfolio?
  • The impact on your tax liabilities, and what sort of capital gains costs you need to budget for?
  • What kind of buy-to-let mortgage products are available, and what fees and interest rates you might expect to pay?
  • How those fees and costs affect the profitability of your planned investment?

Do The Maths And Think Long Term

Choosing how to structure your investments is not as simple as it may have first seemed. Yes, you can potentially reduce the tax paid on profits from rental income by paying corporation tax, rather than income tax. And yes, as a limited company you’ll be able to deduct interest payments as allowable expenses. However, there are various additional costs that come with creating a limited company, as well as difficulties around getting financing, releasing equity, and higher costs associated with selling the property.

In fact, if you run the numbers you may find out that you’d actually lose money long-term on your investments with a limited company. As such, It’s a good idea to speak with a specialist tax advisor, financial advisor, or an independent mortgage broker to assess your personal situation and advise on the best approach for you.

Final Thoughts

When investing in property you need well-developed investment management and exit strategies. You should have systems in place designed to streamline your workflow and allow you to minimise overheads and maximise profits.

Software like Landlord Studio can help you track and report on your income and expenses, giving nuanced oversight of your financials. With this data, you can identify weaknesses and opportunities for improvement. Additionally, with features like bank feed integration, smart scan receipts, and automation, you can save time through reduced manual data entry and tasks.

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