Do I buy a house via my firm?
A common question for those with residential investment property or thinking of purchasing residential investment property is whether it should be owned personally or via a limited company.
Ian Tongue explores some of the considerations to make and provides a real-world example of a common scenario for consultants.
It is reasonable for those who own residential investment property to feel like they have been squeezed with changes to the tax-deductibility of mortgage loan interest, increased stamp duty for second homes and changes to tax relief around expenses on repairs and renewals.
These changes have made people question whether personal ownership of rental property is a viable option. And with the significant amount of consultants trading through a company, it is natural to ask whether transferring or purchasing new property in the company is tax-efficient.
It is easy to look at the corporation tax rate of 19% and conclude that it must be tax-efficient, but to consider the position adequately you need to consider more factors, including the likely future sale of the property.
This article looks at the most common scenario for a consultant who is considering using their trading company to purchase residential property using rolled-up profits compared to using personal savings. Considerations for property trading companies and commercial premises are outside the scope of this article.
Personal ownership
When purchasing a property in addition to your main home, it is subject to the increased rate of stamp duty for second homes, which is a 3% surcharge on whichever rate is applicable based on the purchase price.
If the property is bought outright, the main tax-deductible costs will be letting fees, insurance and general running costs leading to a taxable profit upon which income tax is paid at your marginal rate of tax, for example, 40%.
Where a mortgage is in place, the loan interest is no longer tax-deductible in computing the profit from rental, but you are allowed to deduct 20% of the loan interest against the tax due.
Effectively, the tax deduction available for mortgage interest is therefore limited to 20%, having previously been at your marginal rate of tax, as high as 45%.
Once the tax has been paid on the rental profit, any surplus funds are tax-paid disposable income for the individual.
If the property is sold, capital gains tax is paid at 28% for higher-rate taxpayers and 18% for basic-rate taxpayers on the gain after each owner has deducted any available capital gains tax annual allowances, currently £12,300.
Therefore, for joint ownership with a spouse where no other capital gains are made in a tax year, the first £24,600 is exempt from capital gains tax.
Further reductions to the capital gain assessed may be available if you have lived in the property for a period of time.
Limited company purchase
When purchasing a property through a company, stamp duty is paid at prevailing rates and no beneficial rates apply.
Where a property is already owned personally, stamp duty would be payable to transfer the property to the limited company as though it was purchased from a third party. There may also be capital gains to pay on the transfer.
As with personal ownership, most of the deductible costs will be similar, but any mortgage interest is allowable in full when calculating the profit from rental.
It should be noted that interest rates are often higher through a limited company than personally, but there can be a significant degree of variation in lending policies between banks and other financial institutions.
Once the tax has been paid on the rental profit, any surplus funds become retained earnings in the company.
For this profit to be extracted personally from a company that continues to trade, the profit will need to be distributed by way of a dividend and income tax paid at prevailing rates.
Where the company is ceasing, the retained funds can usually be extracted subject to more beneficial capital gains tax rates, provided that certain criteria is met.
High-value property
Where ‘high-value’ residential property is owned within a limited company, additional tax is payable which is known as an annual tax charge for enveloped dwellings. This was introduced around the time of the mortgage interest restriction came into force as a disincentive to own property within a limited company.
The threshold for this to apply is currently £500,000, which generates a tax charge of £3,700 per year and this increases in line with the property value. While many properties will not be of this level, the threshold level could change, bringing more properties under this charge.
The value of property for this charge is also reviewed periodically and therefore a property may attract the charge through general rises in house prices if the thresholds remain static.
A ‘fair’ comparison
It can be difficult to make a fair comparison of the two ownership structures without knowing the timeline of ownership and prevailing tax rates for both individuals and companies.
We can, however, consider an example based on the current rules and tax rates which is reasonably reflective of a scenario that a consultant could face.
The following are the assumptions for the calculations:
Property purchased for £150,000 – after the Covid stamp duty measures expire;
No mortgage required;
Joint ownership with a spouse and both higher-rate taxpayers;
Sold after ten years for £200,000;
Annual rental of £6,000 per year – increasing by 2% a year;
Costs of £2,000 per year – increasing by 2% a year;
Tax-deductible repairs of £5,000 in year five and nine;
Corporation tax rates of 19% for the first two years and 25% thereafter in line with recent Budget announcements;
The company retains the profit made and these rolled-up funds are extracted along with the gain on the property at beneficial rates in year 10 (see below);
Selling fees are ignored.
Rental profit
Based on the above assumptions, under personal ownership the disposable income (profit after taxes paid) generated for a 40% taxpayer would be c£20,000 over the ten-year ownership period.
For a company where the profit is retained – that is to say, not paid out to the shareholders – the profit earned would be c£25,500.
Round one to the corporate ownership structure it would seem.
Capital Gains Tax
Where things quickly reverse is when you factor in the capital gains tax position.
Under personal ownership, the capital gain after acquisition costs in your pocket would be c£40,000. Add to this the disposable income above from rental activities and you have earned c£60,000 after tax over the ten-year ownership.
The limited company calculation is more complex as the profit on sale of the of property is taxed at corporation tax rates – with no annual exemption – and, following this, the retained profit from rental and the capital gain forms part of the retained profits of the company.
The best-case scenario here is for a further 10% to be payable on the retained earnings at the point of liquidation which would leave c£56,000.
Therefore, based on the assumptions above, the company ownership route was c£4,000 worse than personal ownership.
This would be more significant if the funds could not be extracted favourably from the company in year 10; for example, they were treated as dividends rather than capital gains or capital gains tax rates increased.
Additionally, a spouse who is a basic-rate taxpayer would benefit from higher disposable income from rental profits under personal ownership and lower capital gains tax payable on the disposal.
There are likely to be certain scenarios where the company can work well, but often consultants are looking to invest in relatively low-value residential property using rolled-up funds in their company and so the balance between rental yield and anticipated capital growth is important.
As can be demonstrated in this simple and realistic example, higher annual retained rental earnings for a company compared to disposal income for an individual can be quickly unwound by the level of capital gains tax payable down the line.
It is important if you are considering investing in residential property via a limited company that you discuss matters with your accountant to ensure this is tax-efficient for your circumstances.
Ian Tongue (right) is a partner with Sandison Easson accountants