The news is currently full of headline articles saying that buy to let (BTL) properties should now be held by a company. This is because companies are not caught by the new rules coming into effect from April 2017 which restrict the amount of mortgage interest that can be deducted in calculating rental profits for tax purposes. This restriction is being phased in over four years.
Companies also benefit from a low rate of corporation tax, currently 20% reducing to 17% by 2020 whereas individuals are taxed at 20%, 40% or 45% depending on their personal circumstances.
Whilst it may be a very tax efficient way of holding property over the long term what many of these articles do not highlight is the cost of transferring existing BTL properties into a company. Any transfer will be deemed to be at market value at the time of the transfer so capital gains tax may be payable.
For example, a property originally costing £175,000 is transferred to a company at a market value of £250,000 crystallising a gain of £75,000. After deducting the CGT annual allowance of £11,100 this will result in a tax charge of the remaining £63,900 x 28% CGT = £17,892. This assumes the individual is a higher rate taxpayer and that the property has never been the owner's main residence. The new lower rate of capital gains tax introduced in April 2016 does not apply to residential property.
Stamp duty is also payable on any transfer. So a transferred property worth £250,000 will cost £10,000 in stamp duty, which is payable immediately.
Both these charges will be a one off but need to be factored in to the savings being made by changing to a company. As in the example above the cost would be £27,892.
Other costs that need to be considered are the compliance costs of setting up a new company, such as sorting out bank accounts, annual accounts and corporation tax returns.
Early repayment charges on current mortgages may also apply as any mortgages will have to be taken out in the company's name rather than the individual.
Careful planning is therefore required as the initial cost in transferring BTL property to a company may outweigh any benefits in the short term. The mortgage interest restriction is taking four years to reduce to basic rate tax relief only so landlords have time to plan.
New BTL property purchases might however, be more beneficial for tax purposes to be put straight into a company if the plan is to hold the property for the long term.
If the rental income is required for day to day living then careful thought will have to be given how the income is to be extracted from the company as this might negate some or all of the tax savings by putting the BTL property into a company. If a salary is taken out of the company then normal income tax at 20% / 40% / 45% would be payable. But the company would also suffer employers' national insurance which is currently 13.8%.
It is therefore essential that tax advice is sought before rushing into setting up a property company.