Jatinder is a higher rate taxpayer who owns three buy-to-let properties in Cambridge. Together they are worth £800,000 and his tenants pay a total of £40,000 a year in rent, giving him a yield of 5%.
All three properties are mortgaged, and he has an outstanding debt of £500,000, which he pays interest of £20,000 a year on. The capital repayments are negligible.
New rules introduced in April limit the tax relief he can claim on his mortgage interest payments, and the relief is set to fall further in coming years, steadily driving up his income tax liability.
Jatinder has heard he could escape this tax relief squeeze if he owned the properties through a company rather than as an individual. How practical is this option?
The prospect of paying the 19% corporation tax instead of 40% income tax on the profits he makes from his buy-to-let (BTL) portfolio can seem enticing. But there are several costs and tax liabilities when switching a property from individual to corporate ownership, that could cancel out tax savings.
Jatinder pays £5,000 a year in letting agent fees. In the last tax year, he was left with a net profit of £9,000 after tax and costs were deducted from his £40,000 rental income.
In the current tax year, his net profit will reduce to £8,000, and in 2018/19 it will fall to £7,000. By 2020, he will only be entitled to basic rate tax relief on all his finance costs, so his net profit will slip to £5,000.
The tax relief changes could trigger hidden costs if they push his taxable income into a higher threshold. As his taxable income exceeds £60,000, he will lose all eligibility for child benefit and, if it breaches £100,000, he will start to lose his personal allowance.
If Jatinder were to transfer ownership of his properties to a company, he would face two immediate tax charges: one relating to his sale of the properties and one to the company’s purchase of them.
Jatinder would need to pay capital gains tax (CGT) of 28% on any profit (less his annual exemption) he has made on the properties. The company buying the properties would need to pay stamp duty, including the 3% surcharge for BTL properties, meaning a charge of over £11,000.
Less obvious is the long-term tax liability he would be storing up if the properties increased in value. If Jatinder’s company were to sell the properties for a profit, the capital gain would be taxed at 19%, as corporation tax rather than CGT.
However, the company would not be eligible for the annual allowance, currently £11,300, that individuals can discount from their CGT liability. It would pay a lower rate of tax with an allowance for inflation, so only the economic gain on the property is taxed.
Jatinder would incur further tax on the rental profits and any gains on selling the property. To keep his tax exposure down, Jatinder could pay himself in dividends rather than drawing a salary from the company.
Jatinder would need to file yearly accounts and returns at Companies House for his company, and claim exemption from the annual tax on enveloped dwellings.
Tax concerns aside, the feasibility of the idea hangs on how easily he could remortgage. His company would need to secure a corporate mortgage for the properties. These will have different lending criteria and may charge higher interest rates.
Transferring his property portfolio to a company is not a soft option. It will have multiple tax implications and expenses.
It would be different if he did not yet own the properties. Someone keen to start a BTL portfolio might find the corporate structure route more attractive than Jatinder.
Tim Walford-Fitzgerald is partner at HW Fisher & Company.