As landlords, exploring the various ways to manage your rental properties is crucial in optimizing your business operations and maximizing your income. One such strategy is incorporating your rental properties into a limited company. However, this transition might seem complex, especially when you consider the potential tax implications. This article will dissect the tax considerations that you need to be aware of before making this significant decision.
Understanding the Basics of Property Incorporation
Before delving into the tax implications, it is crucial to understand what property incorporation involves. As landlords, you may choose to incorporate your property portfolio into a limited company. By doing this, you essentially shift from being private landlords operating as individuals to becoming directors of your own limited company. This approach has certain tax benefits but also involves various complexities.
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Primarily, the main shift is how your rental income is treated for tax purposes. As private landlords, the income generated from your properties is considered personal income and is taxed accordingly. However, once incorporated, the rental income becomes the company’s income and is taxed under corporation tax, which typically has a lower rate.
The Impact on Income Tax
The way you’re taxed on your rental income will significantly change once you incorporate your properties. As private landlords, your rental income minus allowable expenses is treated as your personal income and taxed accordingly. This tax is often significant, especially if you’re a higher or additional-rate taxpayer.
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Following incorporation, your rental income is treated as the company’s income. As a result, it is subject to corporation tax, the rate of which is significantly lower than the income tax rates for higher earners. This shift could lead to substantial savings in income tax.
However, it’s important to remember that when you want to access the profits of your limited company, you will have to either pay yourself a salary or receive dividends. Both these methods will attract further tax, potentially negating the benefit of the lower corporation tax rate.
Capital Gains Tax Considerations
When transferring your properties into a limited company, you’re essentially selling them to the company, even though you’re still the ultimate owner. This transaction can result in a capital gains tax (CGT) liability if the properties have increased in value since you bought them.
However, there’s a relief known as incorporation relief which can help mitigate this CGT liability. To qualify for this relief, you must be actively involved in managing your properties as a business rather than just passively receiving rent.
Mortgage Interest Relief Changes
Mortgage interest relief changes are an important factor that has been driving many landlords towards incorporation. In previous years, landlords could deduct all their mortgage interest and other finance-related costs from their rental income before calculating their tax.
However, these rules have now changed, and landlords can no longer deduct their mortgage interest from their rental income. Instead, they receive a basic rate reduction from their income tax liability for their financing costs.
In contrast, limited companies can still deduct mortgage interest and other finance costs from their rental income before they pay corporation tax. This difference can significantly reduce the effective tax rate on your rental income.
Insurance and Other Running Costs
After incorporating your properties, your company becomes responsible for property-related expenses, including insurance. Insurance premiums paid by the company are considered business expenses and are therefore tax-deductible. This factor can reduce the company’s corporation tax liability.
Moreover, running costs such as repairs, maintenance, and property management fees can also be offset against rental income, further reducing the company’s tax liability.
However, it’s essential to be aware that these expenses must be solely for the purposes of running your property rental business. Personal expenses cannot be claimed as business expenses.
Incorporating your rental properties into a limited company can have significant tax benefits. Nonetheless, it’s a serious decision that needs careful consideration of both the advantages and potential tax implications. It’s always recommended to seek professional tax advice tailored to your specific circumstances to make the most informed decision.
Stamp Duty Land Tax (SDLT) Implications
When you transfer your properties into a limited company, you are technically selling them to the company, and it is crucial to consider the implications of Stamp Duty Land Tax (SDLT). SDLT is a tax on property or land bought or leased in England and Northern Ireland.
In the eyes of the law, your limited company is a separate legal entity from you. Therefore, the transaction is considered a sale and purchase, even though you are the ultimate owner of the properties. This transaction will attract SDLT based on the current market value of the properties.
There are, however, some potential exemptions and reliefs. Multiple Dwellings Relief (MDR) allows you to pay the SDLT on the average price of the properties in a transaction, rather than on the total price. This may reduce the SDLT payable. However, you need to be aware that the minimum rate of SDLT under MDR is 1%, even if the average price falls within the zero-rate band.
Further, if you are transferring a portfolio of six or more properties, it may be treated as a commercial transaction, and different SDLT rates can apply. It is always advisable to get professional advice on the potential SDLT liability before you decide to incorporate your rental properties into a limited company.
Annual Tax on Enveloped Dwellings (ATED) Considerations
The Annual Tax on Enveloped Dwellings (ATED) is another potential tax implication to consider when incorporating your rental properties. ATED is a yearly tax payable by companies that own UK residential property valued over a certain threshold.
You should be aware that ATED charges apply to properties valued at more than £500,000 as of the last valuation date (1 April 2017). If your rental properties exceed this value, your limited company may be liable for ATED, with the charges increasing progressively with the value of the property.
However, there are reliefs available that can reduce the ATED charge, potentially to zero, if certain conditions are met. For instance, if your properties are rented to a third party on a commercial basis and aren’t occupied, at any time, by anyone connected with the owner, you could qualify for relief.
Furthermore, ATED is only applicable if your property is considered a ‘dwelling’. This means it’s a place that someone can live, including any gardens, grounds and buildings within them. Certain properties, like hotels, guest houses or student accommodations, are not considered dwellings for ATED purposes.
Consequently, while the ATED rules seem daunting, many rental properties may not be affected or could qualify for relief. Nevertheless, it’s a complex area and professional advice is recommended.
Conclusion
Incorporating rental properties into a limited company can offer several tax advantages, including potentially lower income tax rates, the ability to deduct mortgage interest and other finance costs, and the reduction of corporation tax liability through deductible expenses.
However, you need to be mindful of the potential tax implications, including capital gains tax, stamp duty land tax, and the annual tax on enveloped dwellings. Moreover, accessing the company’s profits will attract additional tax, potentially offsetting some benefits.
The decision to incorporate should not be taken lightly. It involves a significant shift in how your rental business operates and is taxed. You must consider how these changes align with your overall property investment strategy and your personal financial circumstances.
Remember, each landlord’s situation is unique, and what works for one might not work for another. Therefore, it’s crucial to seek professional advice to ensure that incorporation is the right move for your property business. It’s about balancing the potential tax benefits against the costs, complexities and potential tax liabilities involved. Remember, the goal is to optimize your rental income and ensure your property portfolio is as tax-efficient as possible.
