In-depth Review: Tax Efficiencies in Buy-to-let Companies

Introduction:

In the UK, there are two principal ways that you can purchase and own buy-to-let investment property. You can purchase in your personal name or use a buy-to-let company to hold your investment property.

At GetGround, we found that more than 60% of buy to let purchases made in 2020 were done through companies, as opposed to just 15% in 2015. There are now more than a quarter of a million limited companies that exist to hold investment property.

A key reason many investors choose to hold a property under a company structure is due to tax efficiencies. For this article, we will be focussing on clarifying the overall efficiencies provided by a company structure throughout the entire course of a buy-to-let investment lifecycle.

In particular, we will cover: 

1. Advantages during the purchase process
2. Advantages during the ownership process
3. Ways to efficiently extract income
4. Advantages during a sale process
5. Inheritance considerations

Key terms we will cover:

• Stamp duty land tax (SDLT)
• Corporation tax
• Capital gains tax
• Inheritance tax
• Dividends 
• Pension contributions

Before we continue, this content is only meant to be a helpful guide on how to think through tax components when considering company buy-to-let and should not be relied on as advice. We strongly advise you seek professional tax advice specific to your own circumstances if you are unsure of the tax outcomes of a particular course of action.

(1) Advantages during purchase:

Stamp Duty Land Tax (SDLT) is the same in limited company name and personal name:

There is a common misconception that when purchasing an investment property in a limited company, there are higher entry costs such as higher rates of Stamp Duty Land Tax. This is not the case. For individuals that already own one property elsewhere (be it in the UK or globally), the entry costs are identical when purchasing under your own personal name or in a company.

Reduce the cost of your future home purchase:

If you were to purchase your first buy-to-let investment property under a company structure, you can still qualify for First-time Buyer’s Relief on your first home purchase, and may not have to pay SDLT given the relief scheme. 

One of the main conditions of First-time Buyer’s Relief is that the individual has never owned residential property before. Therefore, if you invest in buy-to-let in your own name you won’t be eligible for first time buyers relief.

(2) Advantages during the ownership period:

There are also significant benefits to a company structure during the ownership and sale phases.

Deduct your mortgage interest from your tax bill:

The first efficiency to consider here is that when owning your property in a limited company, you can deduct your entire mortgage interest cost from your profits before the tax is calculated which reduces your tax bill. You can no longer do this when you own your property in your personal name, and this has now been replaced by a basic rate credit.

Let’s take a look at a basic example. Let’s assume we have rental income of £3,000 per month, a mortgage interest cost of £650 per month and other property related expenses of £350 per month.

When using a limited company to hold your property, you can deduct all of these costs, which in this case would result in a total £2000 profit. This means that you only have to pay tax on the remaining profit left over, after deducting mortgage interest cost. 

Paying corporation tax rather than income tax:

If you own a buy-to-let property in your personal name you will have to pay tax on the rental income, this can reduce the profits from a buy-to-let property investment particularly for high rate taxpayers and reduce the efficiency of the investment

When setting up a company structure for your buy to let property, you are subject to paying corporation tax rather than income tax.

Corporation tax is due on your company profits, and importantly is currently 19% (and with respect to the recent budget, will remain at 19% for companies with <£50k profits post April 2023). This is in comparison to income tax rates of between 20% and 45%.

(3) Efficiently extracting cash:

Now that we have maximised the profit left in the company, we must consider how to extract this cash from the company over time. 

An important benefit of using a limited company for buy-to-let investment is that we can extract cash efficiently to maximise what we can receive from each buy-to-let property.

Over time, when you receive rental income, or when you sell that property, cash can accumulate in your company account. You can choose to reinvest it in other properties, or leave the cash in your account. 

However, at some stage you would likely want to withdraw cash from the company account. This is a point at which many investors can make costly mistakes 

For example, many investors assume that paying themselves a salary from the company is the best way, which is not necessarily the case. 

Rather than paying yourself a salary from the company, there are potentially three efficient ways of extracting cash:

1. Dividend payments
2. Director/owner loan repayments, or
3. Pension contributions.

Dividend Payments:

Dividends are essentially payments made from company profits to shareholders in the company. Shareholders are individuals which hold shares in your company, and can be your family members or joint venture partners. 

Dividend payments are made by instructing your company to transfer profits from the company account to your personal account, and this can be done as regularly as you like so long as the company has built up an accumulated profit pool sitting in your bank account (more technically called distributable reserves). 

The reason dividend payments are an efficient way of extracting profits from your company is because, if you are a UK resident, you will receive a dividend tax-free allowance for the first £2000 each year, regardless of how much income you make. 

For investors based overseas, dividend payments are also efficient as dividends paid by UK companies are not subject to any UK withholding tax.

Although the concept is simple, the mechanics of making a dividend payment can be complex. In order to make the transfer, you must hold a board meeting, review the position in the accounts to confirm sufficient profit reserves are available, and then declare the dividend to be paid. It is important to get this right in case these payments are reviewed in the future. 

Director/owner loan repayments:

If you do not want to extract your profits by way of dividends you can extract them through a Director (or) Owner Loan repayments.

A Director’s Loan is a legal agreement between the company and investor that says:

“I, the investor, am lending the money needed to purchase this property to my company. Therefore, my company owes me, the investor, this money back.”

Typically in a buy-to-let case, the individual is the investor in the company, but also he or she simultaneously controls the company. 

Your company, controlled by you, will repay its loan to you, as the investor, over time. When legal documents are structured correctly, the debt holder can be asked to be paid at any time. Repayment of a debt is not income and therefore not subject to income tax. 

Pension contributions:

One of the most efficient, yet least common ways of extracting your buy-to-let profits from your company is through pension payments.

As a director of your company, you can make pension contributions from the company to your pension pot. Pension payments can be treated as an expense, and as such are deductible from your gross income. This reduces the profits on which corporation tax is calculated.

However, when pursuing this strategy, keep in mind that typically you would not be able to access your pension pot until you are 55. But this depends entirely on the scheme.

(4) Benefits on sale:

At some point throughout the investment you, or your children, may wish to sell one or more of your investment properties. If you own them in a limited company there are key advantages when you sell.

Owning a BTL property in limited companies increases the way in which you can sell your property, for instance, your company can sell the property or you can sell the company by selling shares in your company.

When you sell your buy-to-let property by selling the company shares , you can dramatically increase the returns on your investments for two reasons.

Price advantages from no SDLT:

When selling your property by selling the company shares , the buyer pays stamp duty tax as opposed to paying SDLT (stamp duty land tax). Stamp duty taxes are charged at 0.5% compared  to SDLT where, depending on the price of the home, rates can be as high as 15% of the property price.

This means the seller has a price advantage.

Let’s take an example where a buyer pays £20,000 in Stamp Duty Land Tax to purchase the property directly. In the scenario where she purchases shares in a company instead, she no longer has to pay this £20,000, but instead, pays £500 in stamp duty. As a result, the seller has considerable price advantage to charge, say, £15,000 more in asking price. 

From the buyer’s perspective, she would still be happy to purchase at this price as she is (i) purchasing the property she wants to buy (ii) now receiving a discount on the overall property purchase.

Lower Capital Gains Tax:

The second reason is that selling property by way of a share sale can increase your overall returns as it attracts a lower tax rate vs. directly selling property. 

Selling shares in a company typically attracts anywhere between 10-20% in capital gains tax, whereas selling your property directly can attract anywhere between 18-28%. 

However, if you are a non-UK resident, make sure to check how your local capital gains tax system works. Your tax ranges might differ from what a UK resident may get. 

(5) Inheritance advantages:

For those investors who do not wish to sell, using a limited company to purchase and hold your buy-to-let investments can allow you to easily pass on your investments to your children. 

Passing on a property to a loved one as part of their inheritance is often quite a cumbersome process and can sometimes be seen as a challenge, especially for individuals in the UK.

When owning property in a limited company, you can simply gift shares in the company to your children.

It is also a valuable way of passing your properties onto your children as it means you, as one of the directors of the company, can remain in control of the company, the property, and all associated elements.

You should also consider your capital gains tax position when considering this advantage. If the value of shares / property has increased beyond the original price when you make the gift to your children, there may be capital gains chargeable on the gain made once all relevant capital costs have been deducted. 

Again, we would like to reiterate that this content is only meant to be a helpful guide on how to think through tax components when considering company buy-to-let. We strongly advise you seek professional tax advice specific to your own circumstances if you are unsure of the tax outcomes for you personally of a particular course of action.