Landlord Tax Efficiency: What’s the Cheapest Holding Structure for You?
What do you know about holding structures?
Given the current economic turmoil, we’re all keen to make sure we’re not paying over the odds. It’s never made more sense to try to keep as much money firmly in our wallets as we can.
This is true across the board, be it turkeys, telephone bills or a tank of fuel – but what about tax? How do landlords know they’re not paying more than they need to on rental income?
That’s why we invited tax whizz Richard Cunningham onto the Mashroom Show to talk us through the most efficient ways to hold your properties. And not only could the right structure save you cash, but it could streamline your portfolio and make your tax return easier.
In our previous show Richard talked about income tax and allowable expenses, so be sure you don’t miss that one either as it too could save you a few quid.
What are holding structures?
Holding structure is the legal manner in which you hold the property according to the Land Registry
‘From a tax perspective, if you get it right, you’re looking at minimising your income tax, capital gains tax and your exposure to inheritance tax,’ Richard says.
But what are the various holding structures to choose from?
1. Personal name
This is the simplest option, but it might not be the cheapest. You hold the properties in your own name, as an individual. That means it’s probably the most sensible option if your affairs are very simple, i.e. if you’re single and don’t have any children.
The downsides are that individuals are subject to capital gains tax and income tax, plus the market value of any property is included in your estate upon your death so could be subject to inheritance tax. ‘It’s possibly the least flexible option, but probably the best if you only have one property. It’s suited to so-called ‘accidental landlords’ who may have inherited a property,’ Richard says.
2. Joint names – and it’s not just married couples
If you buy a property with your spouse, everything is automatically divided 50-50, and that includes tax on rental income. But a half-and-half split could cost you money, Richard warns. Say one partner doesn’t work and the other works full time. The working partner’s rental income will be taxed more heavily because they’ve probably already used up their tax-free allowance thanks to their job.
Happily, there’s a way to get around this: you can split the beneficial interest in favour of the lower earner so that you can both make full use of their tax-free allowance. ‘It’s a straightforward process,’ Richard says. ‘There’s a simple declaration of trust – Form 17 – that you file with the Inland Revenue, and they accept that as fair tax planning.’ So, that works well … as long as you stay together!
But what if you’ve bought a property with a friend or relative? Unlike married couples, there’s no default split of 50-50; taxation automatically follows whatever ownership shares you agreed when buying the property (although you can agree to a different split and file a Form 17).
And if you’re setting up a buy-to-let partnership, the next option is certainly worth considering…
3. A limited company
You’ve heard of it, but what is a limited company, and why could it save you money?
‘It’s a separate legal entity, registered at Companies House,’ Richard explains. ‘It requires a director, and that director has responsibilities, so it’s important to understand that before leaping in, and to take some legal advice.’
Limited companies have become a popular structure in recent years, and as with any option, there are pros and cons depending on your situation. Unlike individuals, who pay income tax, limited companies pay a 19% corporation tax on their profits, which works out as a cheaper option for many.
Plus there is no restriction on mortgage interest relief, and there’s a long-term cashflow advantage as well.
About 11% of all landlords (300,000) use a limited company as their holding structure, so nearly 90% aren’t doing it for some reason. Could some landlords be missing out?
‘If you’re an existing landlord and you have a portfolio of properties, incorporating – i.e. moving everything into a limited company – isn’t necessarily a simple process, and it can be expensive,’ says Richard. ‘But if you’re about to set up as a landlord it’s much easier.’
‘This is definitely not something you can do yourself if you have an existing portfolio,’ Richard is quick to add. ‘There are steps you can take as part of the process to make it even more beneficial. For instance, if you have children who aren’t using their personal tax allowance, you could give them shares, but you really need your accountant to help you. It’s definitely not a one-size-fits-all solution.’
For about the last fifteen years the use of trusts has not been as beneficial as in the past, Richard says. ‘The income tax and capital gains tax situation isn’t anything special, but it can be a useful option for some. ‘If parents want to pass on a property to their kids but don’t want them to have it immediately, they put it in trust for the kids,’ Richard tells us.
‘Again, you’ve got issues around capital gains tax, but there are reliefs you can take advantage of. Trusts are usually most useful when it comes to inheritance tax planning, but there are important points to bear in mind. To make it work from an inheritance tax perspective, the person who sets up the trust can’t benefit from that trust, or it would be considered in their estate, and liable to inheritance tax,’ Richard warns.
Which structure is best for me?
‘The best advice I can give is to take some advice. Find yourself a chartered accountant, find yourself a chartered tax advisor. They’ll be happy to give you some of their time without charge. There are a lot of banana skins in the process but they can walk you through it.’
To hear the whole conversation, watch the episode now, and be sure to catch the third and final part of our tax series on the next Mashroom Show, out on Friday 16th December. It’s our last show of 2022, and it’s the finale of our tax series, this time looking at your tax planning opportunities – what better way to prepare for the coming year? What’s more, straight after the show has aired you can head to the Mashroom Landlord Community on Facebook to ask our expert panel your questions about the topics in the show. It’s a simple way to enter 2023 with confidence and armed with the knowledge you need.