In the run up to the introduction of the additional rate of stamp duty a large number of buy-to-let landlords entered the market or increased their portfolios, in fact March 2016 was the first month on record where buy-to let mortgages outstripped first time buyer mortgages. Some of these landlords had not fully considered the most tax efficient ways to hold a buy to let portfolio .
In this article we explain how the increases in SDLT and income tax relief affect buy to let landlords; and why higher rate tax payers may see savings if their buy to let portfolios are held in limited companies.
Additional rate of Stamp Duty Land Tax
The additional rate of Stamp Duty Land Tax now applies to any purchase by any individual that leaves the buyer with more than one residential property at the end of that transaction. An additional 3% over the existing rate of SDLT is levied, leading to substantial increases in liability on even minor transactions. Companies pay the additional rate on all residential transactions. For further detail on this please see our article Stamp Duty on additional properties
Income tax relief changes
Income tax relief changes restrict the tax relief that landlords of residential properties get for finance costs to their basic rate of Income Tax. These changes only apply to individual landlords, partnerships and limited liability partnerships and are being phased in from April 2017 to full implementation in April 2020.
Income tax relief before 6th April 2017
All finance costs derived exclusively for the purpose of a rental business could be deducted from gross rental income to reduce the taxable rental profits. Subsequently the landlord’s rental income liable to Income tax on property income was reduced.
The new rules from 6th April 2017
Individual landlords, partnerships and limited liability partnerships can no longer claim deduct their finance costs from their rental income to reduce their taxable rental profit. Instead, a basic rate tax reduction will be available on the individual’s (or their partner’s) Income Tax liability. The new rules are being gradually introduced as shown in the following table;
Clear examples of the impact of these changes can be found on the government website .
As shown in these examples, basic rate tax payers are not affected as long as the removal of the relief does not push them into a higher tax bracket. The hardest hit individuals are higher rate tax payers with high finance costs and low yielding property, such individuals may find themselves in a position where the tax they pay on their rental income exceeds their overall rental profit.
Limited Company Ownership
Increasingly individuals are looking to transfer their existing portfolios and new acquisitions into limited companies. For higher rate tax payers, property held by way of limited companies is more tax efficient.
Tax and Other Benefits of Limited Companies
Where a property is held by an individual, their rental income is subject to income tax at that individual’s personal rate (i.e. at a rate of 40% or 45% for higher rate taxpayers). Rental income from properties owned by a company however is subject to income tax at a flat rate of 20%.
Furthermore when a property is sold, a higher rate tax paying individual is liable to pay capital gains tax at a rate of 28%; higher than the corporation tax payable by a company in the same transaction, which would be 20% ( although it should be noted that companies do not benefit from the current £11,100.00 personal CGT allowance).
Other benefits of limited companies include, the protection offered by their corporate status i.e. the limiting of liability to the level of investment, the fact profits can be retained inside companies effectively delaying taxation and providing larger capital to grow a portfolio quicker and the flexibility offered by the ease with which shares can be transferred to successors and avoid Stamp Duty Land Tax or Capital Gains Liability.
It should also be noted that, with the right advice, the process for setting up a limited company is now swift, simple and inexpensive. /p>
Drawbacks of Limited Companies
Although setting up a limited company is relatively easy there are continuing expenses in maintaining one. There are a number of legally required reporting requirements for companies which must be met each year. If professionals are instructed, which is highly advisable, legal fees and accountancy fees will be chargeable for the preparation and auditing of accounts and filing of the requisite documents at Companies House and HMRC.
One area in which limited companies are more restrictive is in their choice of lenders for mortgage finance. Although the situation is improving, not all lenders offer buy to let mortgages to limited companies and the products on offer are often more restricted. This is coupled with most lenders also charging higher rates and fees to limited companies.
While many landlords are purchasing new buy-to-let properties through limited companies for the above reasons, the viability for doing so is not quite so clear cut concerning the transfer to limited companies of portfolios of properties that landlords already hold in their name.
Such transfers can attract large Capital Gains Tax and, particularly through the additional rate, Stamp Duty Land Tax liabilities. A number of exemptions and reliefs may apply to such transfers but it can often be the case that the costs involved outweigh the potential tax savings and intended benefits. Where the transfer is being made primarily for inheritance purposes or for a portfolio where fast growth is essential it may still be an attractive prospect. Appropriate legal and financial advice should be sought when deciding whether a transfer is appropriate as the number of factors in play make reaching the correct decision a complex process.
How we can help
We have a large Property team here at Ronald Fletcher Baker LLP with extensive experience in the buy-to-let market. Whether purchasing or selling as an individual, buying or selling through a limited company or transferring your portfolio we offer a comprehensive service and can assist you with every legal aspect of your transaction.
If you have any queries regarding the topics raised in this article or require advice with a proposed buy-to-let transaction please contact Kadri Abu-Hejleh.