Company rental property
Written by Ray Coman
Tax on gains for company owned property
Income tax savings on company owned property
The ability of a company to save a landlord tax will depend on circumstances. However, recent changes in tax law have significantly strengthened the case for company ownership. Mainly since the March 2016 Budget, an investors’ overall exposure to tax has reduced on properties held in a company while it has increased for properties held privately.
Tax on gains for company owned property
Prior to the Budget changes, companies were rarely useful in saving tax for landlords because of the double tax charge. Any gain on property owned via a company is subject to corporation tax. When the proceeds are transferred from the company back to the investor the gain is subject to further tax. This is because the shareholder needs to take either a dividend or to dispose of a share in order to withdraw value from the company.
However, two recent changes have reduced the impact of the double tax charge. The rate of capital gain on a share disposal has reduced from 28% to 20%, for a higher rate taxpayer. At the same time, the rate of capital gains tax on residential properties owned personally has remained at 28%. As a further benefit, the rate of corporation tax is reducing from 20% to 19% on 1 April 2017 and is scheduled to reduce 17% on 1 April 2020.
The rate of tax on capital gains is 36%. This is the corporation tax rate of 20% on the disposal of property plus 16% capital gain on disposal of the share. The rate is 16% because the shareholders are paid out of after tax profits, i.e. 80% of 20%. The combined rate of tax will reduce to 33.6% if the government’s proposals go ahead. This company rate of 36% compares to a rate of 28% on property owned privately.
In summary, the rate of capital gains tax is still higher on company owned property. However, the savings in tax on income may outweigh the additional tax due on disposal. Moreover, it could be possible to mitigate the tax by a variety of strategies including emigration, distribution of proceeds among family members, reinvestment of proceeds in further property and pension contributions. Pensions cannot be used to hold residential property. However, a company in which profits and proceeds are invested into a pension could achieve exposure to the housing market with considerable tax benefits.
Income tax savings on company owned property
From 6 April 2017, the amount of mortgage interest that can be deducted from rental profits subject to income tax will be limited. This restriction will gradually increase so that by 6 Aril 2020 no mortgage interest can be deducted from taxable profits. In its stead, landlords will benefit from a tax reducer equal to 20% or rental profits. This is a significant change to affect higher rate taxpayers with rental income.
Currently, there is no restriction on the deduction of mortgage interest from rental property owned by a company. For a higher rate, or additional rate, taxpayer, a company could significantly reduce tax payable where loans have been used to finance.
It is possible to obtain tax relief on interest for a loan made to a ‘close’ company. Therefore, an investor could obtain a deduction from taxable income, such as employment earnings, for a loan made to a company for the purpose of buying a property. This is a further benefit since:
- Tax relief on interest is obtained, regardless of the profitability of the company.
- This form of financing facilitates accumulation of funds in the company, which could carry a further tax benefit as explained below.
- Lenders are more favourable about writing out loans to individuals. In broad terms, the legal structure of company increases risks for its creditors as compared with lending to an individual.
The amount of tax relief on interest could be capped for investors with total income in excess of £200,000.
A dividend allowance of £5,000 per person was introduced following the March 2016 Budget. A higher rate taxpayer with no other dividend income could withdraw net rental profits of £5,000 per year with no personal tax liability. To illustrate, a husband and wife co-owning a property could draw a profit of £12,500 a year and pay £2,500 in tax. This compares with £5,000 if the same property is owned individually.
Rather than withdrawing funds in excess of the dividend allowance, the remaining profits could be left to accumulate in the company. Once the company is eventually ended, the store of cash profits can be withdrawn as a capital distribution with significant, resultant tax savings. As explained above, profits would be 36%, or lower if rates of corporation tax fall as expected. This compares with a rate of 40%, for a higher rate taxpayer, on profits from privately owned property. Furthermore, the cash saved by delaying tax could be used to repay mortgage or make further investment.
Non-residents
The company structure could be particularly appealing to a non-UK resident. UK rates of corporation tax are currently competitive. Any personal tax liability, either on dividends or capital distribution would be subject to tax in the landlord’s country of residence. This warrants consideration given that the disposal of UK situated property is subject to capital gains tax regardless of the country in which its owner resides.
Inheritance tax
Property which is transferred on the death of is owner is not subject to capital gains tax. For the beneficiary any capital gain will be calculated as the difference between the value when the property was inherited and when it was eventually disposed. It could be said that death creates a, capital gains tax free, uplift in value. It can therefore be tax efficient to retain property until death. Property which is disposed of less than seven years prior to death could be part of the deceased’s estate. An asset which is transferred less than seven years prior to the owner’s death could be subject to both capital gains tax and inheritance tax.
Retaining property until death could result in a greater overall exposure to tax where it is held in a company. If the beneficiary disposes of the shares in the future the cost of the shares would be set by market value when the property when inherited. To this extent capital gains tax is avoided in the same way as for property owned privately. However, tax on disposal of a company owned property has two elements. The underlying asset will still be exposed to corporation tax. Corporation tax on any gain is established by when the company disposes of its property and not by the date that any of the shareholders transfer their interest.
If structured more carefully however, a company could be used to avoid rather than increase exposure to inheritance tax. A rental property could form too great a part of a person’s wealth to impart as an outright gift to a single beneficiary. A company provides a common structure for shares in the asset (and the income this asset generates) to be gradually passed to children, grandchildren and other beneficiaries in a controlled manner. Given the punitive tax rates applied to trusts, a company could present a more practical method of achieving what in effect used to be the function of a trust.
Recommendations
For a couple, it could be beneficial to own the property in join names to make use of double the dividend allowance each year. For a married couple the ratio in which a property is owned determines the ratio in which rental profits are taxed. However, liability to income tax for company owned property will reflect the amount is shareholder is entitled to be paid. In a company it is possible to establish an alphabet share structure to ensure maximum flexibility about the allocation of dividends. It may be possible to increase dividends to the spouse taxed at the lower rate, without altering ownership in the underlying asset.
It is not recommended to transfer an existing property to a company. The transfer will be treated as a disposal for tax purposes. Therefore, capital gains tax would be payable on the difference between market value and original cost. Even for property that has no taxable gain, stamp duty of at least 3% would probably be payable by the company.
The company structure is best suited for properties that are expected to produce an income rather than a capital gain. This would apply to properties expected to return value through higher yield than through growth in market price.
A company would provide a further tax advantage to a landlord using borrowings to support their investment.
A plan should be put in place to avoid holding the shares on death.
Relevant changes in tax regulation should be closely monitored, and plans adjusted accordingly. An exit strategy should be prepared.
Comments
Transfer of an existing property to a company will give rise to both capital gains tax and stamp duty. I would therefore advise against it. There are tax benefits to holding property in a company because of the avoidance of higher rate tax restriction on mortgage interest. But there are also drawbacks, such as being subject to both corporation tax and capital gains tax on disposal. The tax merits and drawbacks would need to be considered for each case.
Due to the changes in Interest relief, I am thinking to form a management company and account for profit through the company.Also I intend to borrow from a high street lender under the company name.The company will pay off the existing mortgage in my name but the property will remain in my name, as transferring to company will involve stamp duty and capital gains.Do you think this business model can work and will be acceptable to revenue? Also I will be giving personal guarantees to the bank for full market value.