Is it worth moving your buy-to-let property to a limited company structure? See how the new tax rates are expected to impact landlords’ profits…
How do you decide whether it is worth transferring your buy-to-let to a company? This is a question that is on the lips of many investors as they come to terms with tax changes introduced by the Chancellor.
George Osborne has decided to reduce the amount of tax relief that landlords can claim - a decision that will eat heavily into their profits.
Accountants Blick Rothenberg have produced a case study showing how landlords’ profits will fall as a result of the tax changes.
How the buy-to-let tax changes will impact landlords’ profits: a case study
Investors can substitute their own figures into the following calculation to help decide whether they need to change the way their property portfolio is structured.
In the case study, the landlord is a higher rate taxpayer who owns a rental property that was bought in 2011 for £155,000 and is today worth £195,000.
The landlord has mortgage on the property of £122,000, which has an interest rate of 3.5 per cent. It means their annual mortgage payments are £4,270.
The annual rent is £8,100, which results in a tax bill for the current year of £1,532, increasing to £1,746 for the tax year 2017 to 2018.
This is due to the tax relief being capped at 20 per cent and being introduced gradually over the next four years.
In reality, this means that from 2012, you can’t claim a deduction but instead landlords will be given a tax credit that will increase over the next four years to reach the equivalent of 20 per cent of your interest costs.
This will result in the landlord’s profits decreasing from £2,298 in the current tax year to £2,085 by the following tax year. By the tax year ending 2021, their profits will be down to £1,444.
|Loan interest paid||4,270||3,203||2,135||1,068||-|
|Net rental income||3,830||4,898||5,965||7,033||8,100|
|Income tax payable (40%)||1,532||1,959||2,386||2,813||3,240|
|20% tax credit for finance cost||-||214||427||641||854|
|Total income tax payable||1,532||1,746||1,959||2,173||2,386|
|After tax profit||2,298||2,085||1,871||1,658||1,444|
What happens if I set up my buy-to-let within a corporate structure?
You’ll need to sell the property to the company, meaning you’ll need to pay capital gains tax. While capital gains tax has been reduced on other investments, it remains at 28 per cent on gains from property. There is a personal allowance of £11,1000, but any profits over this amount will be taxed at the 28 per cent rate.
(The basic rate of capital gains tax has been cut from 18 per cent to 10 per cent, while the higher rate has been cut from 28 per cent to 20 per cent.)
Landlords who decide to set up a limited company to buy the property will also face a stamp duty charge, which is due within 30 days.
Do you have the cash upfront to pay the tax?
Landlords will need to have the cash upfront to pay these taxes if they decide to transfer their buy-to-let to a company.
In this case study, the landlord will have to pay capital gains tax of £8,092 and stamp duty of £7,250, meaning they’ll need to find £15,342 upfront to pay these taxes.
If the property is sold and transferred to a company set up by the landlord, how long would it take to recover these upfront costs?
If all of the profits are retained in the company and no dividends are taken, it would take this landlord 11 years to recover these upfront costs.
This is due to the lower taxes paid within the corporate structure, which results in the profit made being more than £3,000 in each of the next 11 years.
Upfront tax to transfer property to a company (2016/17 tax rates)
Capital gains tax (‘CGT’) of £8,092
|Current market value||£195,000|
|Less: capital gains annual exemption||£11,100|
|CGT at 28%||£8,092|
Stamp duty land tax (‘SDLT’) of £7,250
|Current market value||£195,000|
|£125,000 at 3%||£3,750|
|£25,000 at 2%||£3,500|
Total upfront tax = £15,342