Everything you Need to Know About Incorporating Your Landlord Business
Should landlords be utilising limited companies?
Landlording is a funny old business. You may start out as an accidental landlord or go into it with a deliberate plan to become a property mogul. But however you plan to make your millions, one thing is for sure, structuring your business right is as important as the structures you are letting out.
That said, business structuring, and the tax implications that go along with it is hardly the most glamourous, or understandable topic. So, in a bid to ensure that landlords know exactly where they stand and are making the most of all the options available to them, we’ve enlisted the help of landlord tax supremo Richard Cunningham, a chartered accountant and chartered tax advisor, who is going to talk us through the options out there.
Limited Company options
Moving from a sole trader to a formal business structure sounds like a very grown-up step, and for many landlords seems like a complex option. Lots more paperwork, more admin, more risk.
But is this really the case? Are we missing a trick?
We asked Richard to talk us through moving to a limited company structure, one of the most common options chosen by landlords, and the benefits.
‘A limited company is a separate legal entity, with limited liability’, explained Richard. ‘The shareholders liability is limited to the share capital that they actually put into the company that requires a director to run and to operate it, and it’s that protection that provides comfort.
There’s some big upsides to that. Potentially, the first one is low tax rates. Corporate rates are lower than personal income tax rates. So, at the moment, you’re looking at 19% of your corporate rates. They are actually going up to 25%. But the first £50,000 will be 19%. Thereafter, there’s a kind of marginal relief up to £250,000 after which you’re into 25%.
One of the big advantages is that you’re only subject to income tax to the extent that profits are actually drawn from the business, this creates an advantage particularly where you’re highly geared. So you’ve got a big mortgage, large capital repayments.’
Well, that sounds ideal! How does it work in real life though?
‘Let’s say you are carrying on your rental business as an individual, and you make £10,000 worth of taxable profits. You’re going to be subject to £10,000 tax. You might be a higher rate taxpayer at 40%, so it’s £4,000, but half of that £10,000 profit might actually be used to repay some of the capital and your mortgage.’
‘However, with a limited company, you’ve got a similar situation, but you are taxed at corporate rates. You’re only taxed on income tax rates and you’re actually able to draw those profits out. So, if actually you’ve used £5,000 to repay capital, you’ve only actually got £5,000 in your pocket, you just pay income tax on that £5,000.
And if you’re not going to take it out at all, and you’re going to reinvest it into more properties, then you’re only ever going to be subject to corporate tax rates’.
What are the cons of a landlord limited company?
Sounds like a no-brainer right? Saving huge chunks of taxable profit? Well, hold on, before we all rush to incorporate, let’s just check with Richard that this isn’t too good to be true (yes, yes, I know, boring, but sensible…)
‘There are potential adverse tax consequences of doing so’, warned Richard. ‘The transfer of your properties into the company is a taxable event for capital gains tax’.
Eugh. Capital gains tax. Every property investor’s favourite three letter phrase. Go on…
Let’s say you’ve got a million quid’s worth of property. You transfer them in – they cost you half a million quid. You’ve got a capital gain of half a million pounds so that point of transfer, you’re going to have to pay potentially 28% on that half a million pounds, within 28 days.
Is there any help available to incorporate?
Sounds like moving into a different structure is a pricey option. Is there any help available to make it more viable?
‘There are some tax reliefs that you can take advantage of when incorporating for both capital gains tax and on the strategy side’, said Richard. ‘For capital gains tax, there’s something called incorporation relief, which enables you to effectively defer the gain that would normally arise into the value of the shares that are being issued to you. You’re effectively holding over that gain to a future event, which would normally be a sale of those shares.’
‘The challenge is you have a number of hoops that you have to jump through to benefit from incorporation relief. And essentially, you’ve got to be carrying on what’s termed a business, and the revenue can quite kind of tight in terms of ensuring you meet those requirements. And really, you’ve got to be an active landlord.’
If you’re a landlord with three or four properties and you’ve got an agent manage them for you, it’s very much passive income, so you’re unlikely to benefit from incorporation relief.
‘On the stamp duty side, there are other reliefs too. If you are holding your portfolio in a partnership and you transfer into a limited company, essentially in simple terms, the ownership structure of the partnership mirrors the ownership structure of the limited company, then there is a relief from stamp duty – but it has to be a true partnership. And most people don’t carry on their letting businesses as a partnership.’
What responsibilities would I have?
So, from a tax point of view, there’s definite pros and cons. But what of the admin? Being a Director of a company sounds like a lot of work, is it really as complex as it sounds?
‘As a Director, you have responsibilities in law effectively, as companies are governed by the Companies Act 2006. You have to behave in a certain way when managing your company,’ said Richard.
‘You’ve got to act in the best interest of the company and if you have other shareholders, you’ve got to be very careful around things like conflict of interest. It’s not to be taken lightly. If you’re going to go down this route, you need to educate yourself.’
Best options for landlord expansion
There’s lots of talk at the moment of landlords looking to exit the market, which means there could potentially be plenty of rental properties up for grabs for anyone looking to expand their portfolios. If you’re looking to invest in new properties in the coming years and grow your portfolio, are there any particularly good options for structuring your business to get the best bang for your buck?
‘There’s nothing to stop you from setting up a new limited company, and buying your property through that limited company’, explained Richard.
There are pros when you’re setting up from scratch it from income tax purposes to for inheritance tax purposes. With income tax, often when people set up a limited company, it’s often husband and wife or partners, and they’ll just issue two shares to normal shares. You have a share, your partner has a share and income is distributed equally.
‘But it’s often not the case that both partners pay the same rates of income tax. Your partner might be a higher rate taxpayer, you might be a basic rate taxpayer. If you’re the basic rate taxpayer, you really want to be taking more of the income, because you’re going to pay basic rates. The great thing about shares in limited companies is what’s called the Articles of Association – you can vary the rights of those shares.’
Would that mean that the partners are uneven within the set-up of the company? Or is it purely for tax purposes? How would it work in practice?
‘For example, what you could do is you could say, “Ok, I’m going to issue an A share to my partner, and I’m going to have a B share, and I’m going to pay dividends just on the B shares. I’m not going to pay any dividends to my partner’s A shares”. In that instance, any of the income that you’re taking out is just taxed on you at the basic rates until you hit a higher rate. There’s a clear income tax advantage there,’ said Richard.
‘You can start to take things a step further too. We all know that kids can be expensive to maintain! They usually don’t have their own income, but they do have a personal allowance. There are ways and means of getting income or shares allocated to kids and declaring income on those shares, to make use of your children’s personal allowances to pay for their expenses. If they’re over 18, there’s nothing to stop you just giving them shares and declaring dividends on them and then having the income.’
Clearly, there’s a lot more to this than just bringing in the whole family and making use of their personal allowances, so when you’re getting to this stage of planning, it’s always a good idea to consult with a tax professional like Richard, but it’s handy to know that there are a few ways to minimise liability!
‘Absolutely, it’s one that requires advice,’ laughs Richard. ‘You’re going to need a tax advisor, you’re going to need a lawyer as part of the setup as well.’
Future proofing your portfolio
Talking of children, although this always feels a little morbid, is there anything we can do with regards to mitigating inheritance tax risk? When you’ve worked so hard for so long, it’s super frustrating to think the tax man will chip away at your hard work when you’re gone!
‘If you start you set up your limited company and you give shares to your next of kin, you potentially have the same issue on triggering tax charges’, admits Richard. ‘BUT there are various little tricks that you can use to help reduce future inheritance tax exposure.’
‘For example , you set up a company, and there’s a million pounds of property in there, but there’s also £500,000 of debt against it. You get hit by a bus tomorrow, and that company is going to be valued at half a million pounds for the purposes of your estate.’
‘What you could do (before you get hit by the bus!) is issue some shares to your next of kin – to your kids, grandkids or whoever it may be – and give them the right to future growth. At the point at which you give them shares, they’ve got no value. But you’re freezing the value of your interest in the company at that point, you say about half a million quid. Anything over that value. When you sadly pass away, if your asset value has grown and you’ve got two million quid’s worth of property in the portfolio and half a million quid’s worth of debt, in theory, the value of your estate is 1.5 million pounds. But it isn’t. It’s actually the original 500,000 pounds at the point at which you issued growth shares and effectively froze the value of your interests and rights.’
Is incorporating worth it?
Whilst it will be different for everyone, on balance, do you think limited companies are a good option for landlords today, or are they still a lot of work for not a lot of gain?
‘If you’re running your portfolio as an individual, you might prepare your self-assessment tax return. With the company, it’s very different,’ warned Richard. ‘You still want to do your self-assessment, but you’ve got to prepare full statutory accounts. You’ve got to file corporation tax returns, you’ve got to file an annual confirmation statement to Companies House. There are a lot more responsibilities, and if you fail in your responsibilities, it gets expensive. You need to have an accountant. You really do, the rules are changing all the time. You need to engage someone who’s got their finger on the pulse.’
Take advice, everyone’s situation is different. There’s no one size fits all. A good adviser will be able to tell you whether it’s worthwhile and also identify the opportunities, you know, some of the opportunities that we’ve talked about today.
If you are interested in hearing more from Richard, you can catch up on our tax series from back in December, which covered key details such as allowable expenses, holding structures and tax planning opportunities – all useful info to have!
All of the webinars are available to view on the website.