The business of buying and letting property can be a complicated one; especially as any decisions made on the basis of the tax payable, could well change at various points in the property business life-cycle.
There are a number of potential pitfalls to trip-up the unprepared landlord, so planning ahead is essential. But remember, property investment must be thought of as long-term and tax laws may change with short notice and impact the profitability of the business, so a degree of flexibility is necessary in every plan.
Property Business: What type of property to buy
Commercial property will generally cost more, but the lease periods will be longer, typically at least 5 years. Also, the costs of financing the purchase can be deducted in full. Residential property may be cheaper and easier to let, but much more administration will be involved if tenants change frequently. Also from the 1st April 2016 an 3% additional rate of Stamp Duty Land Tax (SDLT) has been imposed on purchases of buy to let properties.
Whilst SDLT does not apply to commercial property purchases, you must also consider the VAT payable. No VAT will be payable on the purchase of a residential property, but most commercial property can carry 20% VAT, or may be zero rated if the previous owner has not exercised the ‘option to tax’. It is therefore worth seeking specialist VAT advice when buying commercial property.
Purchasing: Individual or through a company?
Buying as an individual will mean that the deduction of interest and finance charges paid will be restricted and replaced by a 20% tax credit which is set against the landlord’s total income tax liability. But if you are a higher rate taxpayer and need substantial borrowings to finance any purchases, it will be far more tax efficient to hold residential properties within a limited company.
If you buy through a limited company, the income received will be taxed at 19%, compared to income tax rates of up to 45% in the hands of an individual. Also, a company can claim a full deduction for all interest and finance charges it incurs to fund the property business, and when you come to sell, if your property business is contained within a company, you can sell the whole company rather than the individual properties. This reduces Stamp Duty for any buyer from up to 15% to a miserly 0.5%.
Your tax position as a ‘buy to let’ property owner
Income from property as an individual is added on top of any other income to arrive at the tax rate, so it could be 20, 40 or 45%, dependent upon your other income. It is also worth checking whether any allowances will be lost by increasing your total income.
For example, if you were a student and have an outstanding balance on your student loan, you will pay 9% of the rental profits as student loan repayments, assuming other income already exceeds the repayment threshold for that type of loan.
Also, if your taxable property income increases your total income above £50,000, you may have some or all of your family’s child benefit clawed back, as the high-income child benefit charge.
Your tax position as a director and owner of a limited company
As I mentioned earlier, if you buy through your own limited company, the company has to pay 19% Corporation Tax (CT) on the Net Profit after all allowable deductions. However, you as the director then have a choice on how to take out the balance of profit after tax and critically, what rate of tax you pay on that income. The choices:
- Income Tax: If you decide to take a salary to extract the profit it will be subject to normal PAYE rules and in addition, as your company is technically your employer, it will be subject to an additional 13.8% of Class 1 NICs on pretty much all of your salary. Whilst the total cost of PAYE is tax deductible, in most circumstances, this choice will result in you paying additional tax, which can be potentially avoided (see below).
- Dividend Tax: As an alternative to a salary, you can take dividends instead. The first £2,000 is tax free and you do not pay tax on any dividend income that falls within your Personal Allowance. How much tax you then pay depends on your Income Tax band (Basic rate 7.5%, Higher rate 32.5% and Additional rate 38.1%). Also, you can reduce your tax burden even further by issuing shares to your wife/husband to avoid the higher rates of tax, or perhaps make use of any unused Personal Allowance they may have.
- Drawdown of Directors’ Loans: Most owners of property limited companies have introduced significant capital into the business to buy the property, this is because typical buy-to-let mortgages give a much lower loan to value, typically resulting in at least a 30% input from you. It is also likely that you will have funded improvements to the property to comply with local authority rules. All of this introduced capital sits on the company’s Balance Sheet as a Director’s Loan, which you can down without any tax implications whatsoever.
In my experience, most directors of property limited companies use a combination of dividends and drawdowns to achieve the most tax efficient result. But be warned, this is a complicated area and you should take professional advice to avoid coming a cropper.
Property Business: How to let residential property
The normal practice is to rent a property using a assured shorthold tenancies; these agreements vary from a minimum of 6 months and a normal maximum of 3 years. The length is agreed upon by the tenant and the landlord with the rent payable not able to be changed during life length of the agreement unless a special clause is included.
However, assuming the property is suitable, you could consider letting it as a furnished holiday let. Letting a furnished property for periods of less than 31 days to each tenant, for at least 105 days a year, can mean the property qualifies as commercial furnished holiday lettings. This allows capital allowances to be claimed on the cost of furniture and fittings, and entrepreneurs’ relief at 10% is likely to be available on any capital gains made on properties on the disposal of the business.
Additionally, business rates, rather than council tax, are payable for properties used for holiday lettings, with up to 100% relief available for small properties, which could well eliminate the rates bill.
Property Business: When and what to sell property
Rather than selling piecemeal, you should consider selling the whole business and claiming Business Asset Disposal Relief (replaces Entrepreneurs’ Relief). This relief allows up to £10m of the capital gains made per person to be taxed at 10% rather than 18% (basic rate taxpayer) or 28% (other taxpayers) for residential properties.
However, Business Asset Disposal Relief can only be claimed when selling the whole, or a substantial part, of the business, if individual residential or commercial properties are sold piecemeal, the relief is not available.