The one change that could increase your buy-to-let profits by thousands
Landlords will be dealt yet another blow when the new tax year begins in April as capital gains tax (CGT) allowance is set to be halved once again.
Just one year ago the CGT allowance – the amount of tax-free profit you could make from the sale of a buy-to-let or any other investment – stood at £12,300. In April 2023 this was cut to £6,000, and from the 2024-25 tax year it will be slashed to £3,000.
The reduction to the allowance follows the withdrawal of mortgage interest tax relief in 2020, making it even more difficult for some landlords to make a profit from buy-to-let.
As a result, many landlords have decided to sell up, and then incur a CGT bill. Between 2021-22 and 2022-23 the number of residential property sales reported to the Capital Gains Tax on UK property service rose by 56pc.
Christopher Springett, partner in private client tax at wealth manager Evelyn Partners, said: “The large increase in the number of taxpayers disposing of residential property is not surprising given the double blow delivered to buy-to-let landlords by tax changes and rapidly rising interest rates.
“We have already seen several clients accelerate the sale of buy-to-let properties to get ahead of any further tax changes.”
But, if you don’t want to sell up, there is one option that might benefit your buy-to-let business, Mr Springett said: “While some landlords are choosing to sell up, others may consider owning their properties through a limited company.”
While operating your buy-to-let business through a limited company can offer legitimate ways to lower your tax liability, it isn’t suitable for all landlords. Here, Telegraph Money reveals what you need to know.
The tax advantages of a limited company
Purchasing a buy-to-let property through a limited company can reduce the tax you pay on rental income, especially if you pay higher-rate income tax.
Taking mortgage interest tax relief first, a landlord who owns a property in their own name can claim just 20pc in tax relief, meaning the rest comes out of what would once have been your profit. But, if the property was bought by your limited company, the full amount of mortgage interest can be deducted from the company’s profits.
For example, say a landlord paying higher-rate tax collects £17,000 in rent each year, and pays £10,000 in mortgage interest. Since the withdrawal of the relief, this landlord would receive a tax credit for 20pc of the mortgage interest, for £2,000. Offset against the 40pc tax due on the £17,000 rental income, this would give a tax bill of £4,800.
But if the buy-to-let is purchased through a company the tax bill would be £1,750, based on 25pc Corporation Tax.
Tax rates for higher rate taxpayers are more favourable in a limited company – or special purpose vehicle (SPV) as it’s known in the buy-to-let sector.
Instead of paying 40pc or 45pc income tax rates, you’ll pay corporation tax. This is payable nine months after your company’s year end. For simple landlords who have one company and earn profits of less than £50,000 the tax rate is 19pc.
If profits or the number of companies the landlord owns rises then you’ll pay 25pc corporation tax.
Lower rates of tax are also paid on profits withdrawn from the company as dividends. While the tax-free dividend allowance is also set to be halved to £500 from April, rates are still lower than income tax. Dividend tax is 8.75pc for basic-rate taxpayers, 33.75pc for those in the higher-rate tax band and 39.35pc for additional rate taxpayers.
Jon Dennis, managing partner of chartered accountancy firm Red 76 Tax, said: “Many landlords don’t extract profits at all, but allow them to accumulate in the limited company to pay for the deposit for their next buy-to-let.”
Landlords can also repay themselves any loan they have made to the business tax-free, for example money lent to the business to pay for a buy-to-let deposit.
“Timing is another advantage of using a limited company to buy properties,” added Mr Dennis. “You get to delay the extraction of profits which will be recorded on your personal tax return, and can choose instead to withdraw cash during a period when any other income you earn is lower.”
Explosion of mortgage choice
Due to increasing numbers of landlords converting their businesses to limited companies, mortgages to suit them have become far more sought-after. Buy-to-let lender Paragon and national broker Dynamo say that 80pc of their new buy-to-let purchase business comes through limited companies.
According to Dynamo there are 1,706 limited company deals compared to 1,818 mortgages for landlords buying in their own name.
Managing director John Cupis said: “The market used to be dominated by specialist lenders but we’re now seeing large high street lenders looking to launch into this sector in the coming months and years because of the growth in demand for these deals.”
Limited company mortgage rates tend to be slightly higher than own-name buy-to-let mortgages, but the increased competition among lenders has caused the gap to narrow.
Fees can be much higher, however. The Mortgage Works is offering a rate of 4.39pc fixed for five years, but charges the limited company a 5pc fee. The good news is, this fee is an allowable expense, which can be deducted from your rental earnings before your tax bill is calculated.
Limited company landlords can also benefit from more lenient lending criteria because of their improved tax efficiency.
Lee Grandin, managing director of Landlord Mortgages, said: “Guidance issued by the regulator states lenders must consider the tax status of the applicant. As the tax status for incorporated landlords is perceived to be favourable lenders generally apply a lower income coverage ratio than they would if they were lending to the landlord directly.”
To be approved for a mortgage, landlords must pass an affordability test. Generally lenders insist that the rent covers the mortgage payment by 125pc if the landlord is a basic-rate taxpayer, or if they are purchasing properties through a limited company, irrespective of their tax status.
For higher rate taxpayers purchasing buy-to-lets in their own name lenders insist that the rent covers the mortgage by 145pc.
Limited company drawbacks
If your buy-to-let portfolio isn’t already set up as a limited company, then transferring existing properties from your own name can be a costly business.
Your limited company must purchase the buy-to-let from you, which means paying stamp duty, including the 3pc surcharge on second homes.
You must also pay CGT on any gain you make after your allowance when it is sold to the company. If you’ve owned the property for a number of years, the gain could be substantial.
Extra paperwork and professional fees are another drawback. Various online companies will do this for you, or you can complete a paper form from Companies House.
You must submit annual accounts and a confirmation statement which confirms the details of the company directors and addresses each year at a cost of £13. Submitting annual accounts and your corporation tax return can cost around £1,500 in professional fees.
When it comes to selling properties held in a limited company, there is no annual CGT exemption amount which means Corporation Tax is payable on the full gain realised.
Nil or basic-rate taxpayers will not benefit greatly from using a limited company; ask a tax adviser to confirm which is the best route for you.
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