Investing in homes? A lot of senior doctors do. But it pays to understand your tax situation and the complexities. Richard Norbury outlines what you need to know.
Many doctors will have, or are thinking about, investing in residential property. This is becoming even more popular as individuals and businesses try and keep pace with higher rates of inflation.
Sometimes individuals will hold an interest in an investment property almost by accident, as properties purchased while in training in a certain city/area or before starting a family are often retained and kept as an investment going forward.
In addition, for those of you who trade via a limited company, you may find cash balances have been kept in the company partly due to a reluctance to vote dividends due to high personal tax rates and to keep under thresholds such as £100,000 (tapering of personal allowances and losing childcare benefits) or £200,000 (tapering of annual allowance for pension).
Property investments are likely to be a medium- or long-term investment, so we must consider that tax legislation can change during the ownership period and residential property has definitely seen some significant changes in taxation in recent years.
Once the decision has been made to invest in property, the next decision to make is whether they should own residential property personally or via a company and there are various considerations that need to be taken into account.
One of the big changes recently has been the rise in corporation tax from April 2023. Depending on the level of profits, you could be paying corporation tax at the rate of 19%, 26.5% or 25%.
If a property is let to a connected person – such as a family member – or the property is not let on a commercial basis, then special rules may apply such that the main rate of tax of 25% could be charged. This should be considered by an accountant or tax specialist.
Sometimes investment property is held in a separate company to the trading company. In these circumstances, you need to consider whether the companies are under common control.
If so, the level when higher corporation tax is paid may be lowered and shared between the companies. Professional advice should be taken on a case by case basis to determine the status.
Annual Tax for Enveloped Dwellings (ATED)
This additional tax for residential properties held in companies is applicable to properties worth more than £500,000. The annual charge varies depending on the valuation of the property and starts at £4,150 for 2023-24.
Exemptions are available if the property is being commercially let, but annual reporting is necessary to qualify for this.
Stamp Duty Land Tax
Most of you will be familiar with the concept of paying stamp duty land tax when a property is purchased.
As with ATED, there is potentially a higher amount of stamp duty paid by companies if the property is worth over £500,000, although relief may be available. In addition, there is a 3% surcharge on residential properties bought by companies.
Capital Gains Tax
Corporation tax is charged at the relevant rate to the individual company based on the sale proceeds of the property after taking into account the purchase price and any qualifying improvements.
Extraction of funds
If we consider that during the life of the company it may be that a residential investment property was bought, rented out and then sold a number of years later, it is reasonable to assume that there may well be money left in the company – after paying corporation tax – for extraction at a later date.
Therefore, income tax is likely to be due on the final extraction of the funds. Dividends would attract tax of the prevailing rates at the time. If the company has ceased trading, it may be the case that it is wound up as a capital distribution in the future.
If so, different tax rates could apply and this could be treated as a capital distribution or income tax may be charged at the prevailing rate. Obviously, any arrangement should be discussed with an accountant or tax specialist to ensure you are making the right decision.
If the company takes out a mortgage to purchase the property, the full amount can be deducted before corporation tax is applied.
However, from a practical point of view, many lenders see property owned within a company as higher risk than owned personally and, as a result, often slightly higher rates of interest are charged compared to properties owned by individuals.
Some companies have the funds available to purchase a property outright. However, for companies that need to apply for a mortgage, many lenders will demand that the company does not have another trade.
This means that separate companies – sometimes referred to as a special purpose vehicle or SPV – may have to be formed to achieve an investment in residential property.
Tax is payable on the profits after deduction for allowable costs in much the same way as the company structure. One large difference is the mortgage interest, which is not a deduction on profits but instead a tax credit of 20% is allowed on any qualifying mortgage interest.
This means highe-rate taxpayers will not get full relief. The rates of tax are then applied at the relevant prevailing personal tax rates.
Residential properties owned outside of a corporate structure are often owned jointly with a spouse or family member. Usually this ownership then dictates which individual the profits are taxed upon.
This can be changed and altered so long as the correct procedures are followed, but careful consideration should be taken, as this could result in capital gains tax implications.
Stamp Duty Land Tax
There is usually a 3% surcharge on top of the prevailing stamp duty land tax rates if buying residential property means you will own more than one property.
This is currently the same rate as residential properties owned via a company.
Capital Gains Tax
Income tax is charged at the relevant rate to the individual based on the sale proceeds of the property after taking into account the purchase price and any qualifying improvements.
Capital gains tax rates on residential property for individuals is currently charged at 18% for basic rate taxpayers or 28% for higher rate taxpayers.
In addition, each individual has an annual exemption limit of £6,000 (2023-24) reducing to £3,000 (2024-25), meaning this element of the gain is tax free, assuming you have made no other gains in the same tax year to 5 April.
If you have ever lived in the property, you can reduce your exposure to capital gains tax. This allows the gain to be reduced such that you only pay capital gains tax on the period that the property is an investment property and not when it was your principal private residence.
As an added relief, if you have ever lived in the property, you also automatically have an additional nine months of the ownership that is exempt from capital gains tax.
This article looks at residential properties that are making a profit and a capital gain. Properties making losses and/or a capital loss need to be considered separately and as part of your overall affairs and strategy.
You can see from this article, there are many different considerations to make and there is no right or wrong answer to whether you should own property personally or in a company structure.
Ownership through a company often looks like a more tax-efficient option, but this can be reversed once the funds are ultimately taken out of the company.
Residential property investment can be a complicated area and taking tailored specialist professional advice specific to your circumstances will help you ensure that you can make an informed decision and be aware of current tax legislation.
Richard Norbury (right) is a partner at Sandison Easson and Co, specialist medical accountants