In our last blog we looked at the growing phenomenon of incorporation, as landlords across the country look toward against the worst parts of the upcoming changes to mortgage interest tax relief. From April this year, the phasing out of mortgage interest tax relief will begin – and will be fully implemented by April 2020.
Firstly, a quick reminder of what incorporation actually means. In essence, it’s the act of forming a limited company, in which – in the case of a landlord – a property portfolio can be placed. The advantage of transferring property to a limited company is that companies won’t be affected by the mortgage interest tax relief changes. They are instead only required to pay corporation tax – which is currently 20%, with frequent speculation that this will be slashed further.
So, in an effort to protect profits and avoid paying more tax, it makes sense for some landlords to consider incorporation. There are, however, pros and cons to this approach. Below, we take a look at what these are…
Under the new rules, landlords will no longer be able to claim mortgage interest tax relief at their marginal rate of tax, regardless of the tax bracket they reside in. Instead, all claims will be made at the basic rate of income tax – currently 20%.
While landlords who are basic rate taxpayers won’t be affected by the changes, the majority of landlords are higher rate (40%) or top-rate taxpayers (45%) and are therefore likely to see their profits severely curbed when the restrictions have been fully implemented.
So, the most obvious advantage of incorporation is avoiding the worst effects of the government’s changes by making use of the tax benefits that being a limited company provides. Once a landlord has incorporated, their tax return changes from an income tax return to a corporation tax return. A landlord’s rental income will no longer appear on this tax return.
Corporation tax is only paid once a year and based on calculated profits. By contrast income tax is paid twice, in January and July, and based on estimated profits.
What’s more, there are no fundamental differences in the way corporation and income tax are calculated. It is done in almost exactly the same way. Corporation tax is set to fall to 17% in the next few years, so landlords who have incorporated would benefit from this cut. In addition, capital gains made on a rental property will be charged at the corporation tax rate.
Lastly, individual or one-property landlords are not barred from incorporating. A landlord need only own one property to make incorporation feasible, as long as a landlord can show that they are treating the letting out of homes as a business and that their activities meet what is known as the ‘business threshold’.
While it’s highly unlikely under this current government, corporation tax could just as easily go up as it goes down. It’s fairly low at the moment, and set to get lower, but this isn’t set in stone. Who knows, after all, what the political situation will be like in 2020, when mortgage interest tax relief will have been fully phased out.
There is a certain amount of hedging your bets here – and at the moment corporation rates are attractive to businesses – but it represents a small risk nonetheless.
Furthermore, incorporating involves a fair bit of work. Working closely with a letting agent, this shouldn’t be a problem for most landlords, but a limited company has to produce formal statutory accounts and submit them to Companies House.
Tax returns may also take longer to complete. None of this is insurmountable, but incorporating won’t happen overnight and, when it does, landlords will need to make sure their accounts and taxes stand up to rigorous scrutiny.
Landlords thinking about incorporation should also note that personal tax will still need to be paid on any profits withdrawn from the company. However, on the up side, there is more wriggle-room and flexibility on tax efficiency when it comes to drawing profits from a limited company.
Still, landlords would be wise to ensure that they have the necessary means to cover their final income tax liability, even after they’ve incorporated. If not, they will have to remove further funds from the company, which could be hit with its own set of tax costs.
Finally, landlords should be aware that capital gains and stamp duty charges will apply when transferring properties from personal ownership to a limited company structure, so the act of incorporation itself also incurs certain costs that need to be factored in.
As emphasised in our last blog, it is essential to get the right advice on the landlord’s specific circumstances before making any changes affecting tax liabilities. The information in this blog is provided only to give landlords something to think about, and is not an authoritative statement on the pros and cons of incorporation. This is a matter for a landlord’s tax advisers taking account of the specific personal and financial circumstances. It always remains a possibility that in future. The Government may tighten up the rules for landlords in this area, possibly making the option less attractive, and again this is an area for advice.
For more information about incorporation, and how to get the most from your rental properties in spite of the upcoming tax changes, please get in touch with Letting Solutions on 01506 496 006. We can point you in the direction of expert advice on the tax issues.
As West Lothian’s first dedicated lettings agency, we have the skills and knowledge to help you maximise your rental yields and keep your tenants happy.
We also offer free and instant online valuations to give you an idea of how much you could be charging in rent.