If you’re serious about turning a profit from your property business, and want to give yourself the best possible ability to grow, you need to consider what the best business structure is for your property operation.
As we mentioned in our last blog post, there are a number ways to minimise the tax you pay on your property income when you’re a private individual and paying your taxes through the self-assessment system.
But when your property empire begins to expand, and profits start to rise, there’s a real benefit to considering turning your property business into a limited company, and incorporating your enterprise with Companies House.
Why you should consider becoming a limited company
Private property owners and sole traders pay income tax on any earnings made from their property income. Your property business finances and your personal finances are one and the same – meaning you’ll be taxed at the current rates of personal income tax.
For the 2016/17 tax year, this could mean paying as much as 45% tax on any income from your property investments or rental earnings.
When your properties are owned and managed through a limited company, you no longer pay personal income tax on profits from your property business. As a registered company, you pay corporation tax on those profits, no income tax – at a greatly reduced rate of tax.
The profits you make and gains on disposal will be taxed at the following rate of corporation tax rate:
- 2016/17 tax year – 20%
- 2017/18 tax year – 19%
- Falling to 17% by 2020.
So, by becoming a company director of your own limited company, you reduce the amount you lose to tax each year – and that can provide the funds you need to invest in new properties, grow the business or take on employees to help you become a more productive and efficient organisation.
You also bring yourself the full advantage of ‘limited liability’, by separating your business profits from your personal wealth and reducing the impact of any losses on your own private income.
There are other key advantages of the limited company business structure when it comes to property income. So we’ve pulled together the top ten considerations you’ll need to factor into your business and tax planning for the forthcoming year.
- Tax on disposal of the property
If you’re a limited company and sell a property, it will be subject to corporation tax, at the rates shown above.
- An indexation allowance is available to companies, with the tax due charged at the corporation tax rates we’ve already mentioned.
- The payment date is subject to the ordinary corporation tax payment deadlines, so you can work this into your annual tax planning.
- If proceeds from the sale are going to be extracted, there will be a further charge to tax for the individual shareholder.
- From April 2013, any gains from property that’s subject to theATED regime (see below) will be subject to ATED capital gains tax, which is charged at a rate of 28%.
- Extracting funds from your company
If you’re the director of a limited company, there’s a potential double tax charge to be aware of and plan for.
If you take profits from the company in the form of dividends, and you’re a higher-rate or basic-rate taxpayer, you may be hit by this double charge. The key is to talk to your adviser and plan any dividend amounts and timings to avoid this potential issue.
Changes to dividend taxation from 2016/17:
- All individuals can receive £5,000 dividends tax-free, regardless of your other income.
- There are three dividend tax bands: 7.5%, 32.5% and 38.1%.
- The tax credit that previously existed has now been abolished.
- Dividends that you receive from pensions and ISAs are unaffected by these changes.
- Capital gains tax and how to reduce it
Your profits can be extracted as a capital distribution on striking off (provided that your assets are less than £25k). Or you can extract unlimited profits as a capital distribution when the company is liquidated, subject to the rules around transactions in securities.
- If you’re a shareholder, expect to pay capital gains tax (CGT) at 10% or 20%, depending on whether you’re a basic-rate or higher-rate taxpayers.
- CGT Entrepreneurs’ Relief won’t apply for a capital distribution from a normal property rental business.
- New rules for transactions in securities have been introduced by the Finance Act 2016, which took effect from 6 April 2016.
- The benefits of ownership as a company
A company can have more than one shareholder, which is another potential benefit of incorporating and making your property business into a limited company.
- You can avoid any potentially costly CGTissues by subscribing new shares when you incorporate the business.
- Family shareholders should be aware of the settlement anti-avoidance provisions, which would apply if you were planning to allocate different share classes to different family members.
- Losses on your property income
Any losses you make as a limited company are locked into the company and can’t be offset against your own personal income – this is where the advantage of limited liability really begins to come into its own.
Any losses you make can be offset against total company profits for the current or future years, as long as your rental business continues trading.
- The Annual Tax on Enveloped Dwellings (ATED) regime
The ATED regime applies to high-value residential properties held by non-natural persons (that means a company, in plain English). However, there’s an exemption from the charge when your property is let on a commercial basis.
The ATED charge will be payable if your letting business stops using the property for rentals; for example, if the property is used by you or your family as a private residence.
From April 2015 properties with a value of £1 million or more are affected; from April 2016 this fell to £500,000.
- The impact of Stamp Duty Land Tax (SDLT)
If you buy a property through your limited company, or it’s given as a gift to your connected company, you’ll be liable to pay SDLT at the market value.
- There’s noSDLT if the property has been held via a partnership prior to incorporation. All property-owning partners must become shareholders.
- From April 2016, a 3% premium applies on the purchase of residential property by companies. And from 1 April 2015, properties in Scotland are subject toLBTT instead of SDLT.
- A similar 3% premium applies on the purchase of residential property by companies.
- Inheritance Tax (IHT) when you’re a shareholder
Your property rental company is a business for corporation tax purposes, and there are some key points to consider when looking at the possible inheritance tax implications of this.
- Property rental is regarded as a non-business activity.
- IHTBusiness Property Relief won’t apply unless your company has significant other non-investment activities.
- On death, a shareholder’s shares will benefit from an uplift to market value in the hands of the beneficiaries. If the properties are held in a company, they won’t receive a similar uplift.
- If the beneficiaries of the shares want to realise their investment, there will be double taxation: the company will be subject to tax on disposal of the property and the individual shareholders will be taxed when extracting the proceeds (from April 2016: if in excess of their £5,000 dividend allowance).
- The value of the shares is likely to be less than an equivalent share of the property because of the potential liability to capital gains tax.
- VAT: Limited company
Income received by your company from property letting is generally exempt from VAT. The exception is commercial letting, which is standard rated if your company has opted for the building to be VATable.
The letting of furnished holiday lets is a standard-rated activity.
- Other considerations of running a company
There are some tax-free benefits if you’re an employer, subject to the wholly and exclusively rule.
If you employ people within your property business, you’ll need to consider the new workplace pensions legislation and auto-enrolment. Even if you only have one employee, you’ll be legally bound to supply a pension scheme for them – and that adds additional pensions costs, admin time and complication to running your property business.
Talk to the property experts
If you think the time is ripe to establish your property business as a limited company, come and talk to the Square Mile team and we’ll help you make the whole process seamless.
We specialise in helping property businesses to get the absolute best from their productivity and profitability. We can advise you on the best structure for your property portfolio and the steps needed to get you incorporated.
Get in touch to arrange a meeting and let’s take the first step towards making your property business more profitable.