It’s no secret that owning a property for rental or development purposes can hold great financial benefits as an individual or a business owner.
If you consider becoming one, there are some tax-related circumstances it’s good to be aware of, whether you decide to own the property as an individual or through a limited company.
In this article, we’ll review the pros and cons of both structures and how each may affect your tax liabilities. You will quickly notice that it certainly isn’t a clear cut in regards to the most suitable ownership path to choose from.
As an individual property owner, most of your profits will be taxed with regard to the tax band your income falls into. Whether it’s rental income or gains you’ve made from selling an asset, your annual income would normally be the primary element HMRC takes into account.
In principle, basic rate taxpayers (20%) would be better off owning the property as individuals while higher rate and additional rate taxpayers (40%, 45%) should be more tax-efficient with registering the asset under the company’s name. Thus, reducing their potential tax liability to 19% with Corporation Tax (2021).
The simplified rationale above will not always apply to the different circumstances affecting your tax bill in reality.
For example, any additional, annual income; either from renting the property or selling it, could take your taxable income above the basic 20% tax rate, hence increasing your tax bill quite substantially as an individual owner.
So, does it mean that you’re always better with a company based ownership, as a higher earner?
Well…the simplest answer is no, or not necessarily.
The reason being is that if you already own the property and would like to register it under your company to avoid the 40% higher tax rate, you should take into consideration the extra costs involved with this transition, which in total; may surpass the tax cost of your higher personal income.
Capital Gains Tax is charged on the profit individuals make when selling an asset (such as an investment property) that has increased in value.
You’ll be taxed for the gain made for that sale. This will be the proceeds received, less the cost paid when the property was originally purchased along with any associated legal costs and improvements to the property (extensions etc). The remaining value will then have the annual Capital Gains Tax allowance of £12,300 deducted from it to produce a gain subject to tax.
If you’ve purchased a house for £150,000 and sold it for £200,000, five years later. The £50,000 gain minus £12,300 CGT allowance, will be taxed as a capital gain.
• The property which was sold was your home.
• Your property or portfolio of properties are listed under your limited company.
Capital Gains Tax is a personal tax, as opposed to Corporation Tax which is a company tax.
The rate at which Capital Gains would be taxed depends on your income and the tax band you’re income is currently in.
For personal income that falls within the 20% basic tax rate, an additional CGT of 18% will be applied, while a higher income of £50,271 will be taxed at 28%.
When the property is owned by multiple owners, capital gains allowance will be multiplied by the number of owners. Hence, decreasing the total amount payable quite substantially.
If a property of 3 individual owners was sold and made a profit of £50,000, the total CGT allowance deducted would be £36,900 (£12,300×3).
This will reduce the taxable profit made from that sale to £13,100 (£50,000-£36,900) and this would be split between the 3 owners.
The profit you make from renting or selling your property as an individual could move your personal income into the higher or additional tax rate of 40% and 45%. Meaning, an additional 28% charge in Capital Gains will apply.
In some circumstances and unless you’ve already bought the property, it may be more beneficial to register it under your company and reduce your future tax bill to 19% via corporation tax.
In principle, basic rate taxpayers (20%) would be better off owning the property as individuals while higher rate and additional rate taxpayers (40%, 45%) should be more tax-efficient with registering the asset under the company’s name. Thus, reducing their potential tax liability to 19% with Corporation Tax (2021).
Incorporating your portfolio under a limited company brings with it significant tax benefits and portfolio management flexibility from a property tax perspective. This becomes an even more viable option for higher individual earners.
That said, it’s important to bear in mind that your personal circumstances may reduce the practicality of incorporating your business, so you are best advising with your accountant and reviewing your finances before making a decision.
Dividends provide company owners with greater flexibility for managing their take-home pay, along with £2,000 tax-free allowance (2021) and a considerably lower tax rate compared with personal income rates.
The amount HMRC will tax your dividends will depend on your personal income and tax band.
The first £2,000 of paid dividends are tax-free.
Above £2,000, you will pay 7.5% if you’re overall income (salary and dividends) falls within the 20% basic tax rate band.
For the ‘higher rate’ and with an income of above £50,271, dividends are taxed at 32.5%.
For the ‘additional rate’ and an annual income of £150,000 and above, the rate goes up to 38.1%.
For more info visit our 2020/21 dividend tax rates guide
Normally, and as long as you manage the avoid the higher dividend tax bracket of 32%, it makes sense to keep a mix of salary and dividend take-home pay for profits generated by rental or a sale of a property.
However, you should be aware that with company based ownership, extracting large amounts of funds from the company, is slightly more complicated and can only be made under certain conditions.
Hence, taking advantage of the lower tax rates paid with dividends is an effective tax-saving tool, but it could limit your short term financial needs in a situation where you would like to take advantage of bigger funds that exist under your company.
One of the significant advantages of having a property or a portfolio of properties registered under limited company ownership comes with the ability to offset your mortgage interest as an expense, against your rental income tax. In this circumstance, the tax-saving benefit becomes even greater for higher earners.
It is important to bear in mind though, that mortgage interest rates tend to be higher for limited companies than individual owners.
It is also worth noting that lenders can also have more stringent conditions when lending to Ltd company vehicles as opposed to individuals. We always recommend taking advice from an independent broker before proceeding with any application as they will be best placed to advise on any potential restrictions that could arise.
Typically, it’s much easier to share or transfer ownership via a limited company. Appointing directors or buying another partner’s share of the asset is an inherent process within the company.
The same transition of ownership for individuals, whether it involves adding your spouse as an owner or registering the property under a limited company, would entail additional tax costs such as Capital Gains (18% to 28%) and Stamp Duty (for purchases above £250,000 from July 2021 and £125,000 from October 2021).
One of the significant advantages of having a property or a portfolio of properties registered under limited company ownership comes with the ability to offset your mortgage interest as an expense, against your rental income tax. In this circumstance, the tax-saving benefit becomes even greater for higher earners.
If you’re renting the property and owning the asset as an individual, your tax liability will be calculated by the tax band your personal income falls into. Hence, 20%, 40%,45% tax rates.
For company-based ownership, rental profits or losses will be calculated within your corporation tax return, at a 19% tax rate (2021).
In that sense, a limited company may serve as a better tax-saving tool.
However, you always need to take into account annual increases in income which may shift you to a higher tax band.
In this article, we have tried to review some common scenarios which can affect your tax liabilities as an individual property owner or a company based one and illustrate the complexity of property management from a taxation point of view.
Furthermore, there are many more circumstances that could change your tax position for better or worse.
We always recommend advising with one of our property accountants and review your finances before making a final decision.
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