What is the best business structure for property investors?

An investment in residential property is still a worthwhile business venture, despite the changes to tax legislation in recent years. The property market is ever shifting and evolving, but one thing is constant - in order to be successful in property investment, you need to decide on the best ownership structure.

Those wishing to invest in property can do so either as an individual or through a limited liability company. The latter is a more popular option since the recent change to tax laws. Each structure has its own tax implications and pros and cons. Which one is right depends on your business goals.

The most common question we are asked by property investors is 'do I take the limited company route or buy in my own name?' The answer, as with most tax matters, is it depends! The starting point is to set a clear objective for your property investment activities. We've put together this informative article to guide you on which business structures are most beneficial in different circumstances.

If you are looking for an experienced chartered tax advisor to support your property investment business, then Walji can help. We provide specialist accounting advice and services to individual investors and property companies to help them get the most out of their investment and to achieve their business goals. Please contact us to apply for a call.

Which business structure should I choose for property investment?

Your decision should be based around several things, most importantly, your business objectives.

You could be planning to: 

• build a portfolio of properties from which to generate a passive income 
• invest with a view to add value to a property that you then intend to sell to earn a profit that you will reinvest in other property 
• invest your life savings in property to give you a pension for your retirement. 

Whatever the objective, it's important to have this clarity at the outset so that the company structure you choose is tailored to your needs and yields the best results. 

Before we move on to the pros and cons of property investment through a limited liability company, let us examine the recent changes to tax legislation that has led more investors to go down the company structure route.

How have recent tax changes affected property developers?

There has been three main changes to the tax treatment of rental income in recent years, that adversely affected buy-to-let property owners. These changes have made owning property through a company structure a more worthwhile option for investors.

1. Introduction of 3% stamp-duty surcharge 
2. Abolition of 10% wear and tear allowance 
3. Removal of tax relief for mortgage interest 

Introduction of 3% stamp duty surcharge 

In April 2016 the government introduced a 3% surcharge on any purchase of a second property by an individual as a reaction to the country’s housing crisis. Whether this has been successful is a debate for another day! 

The surcharge applies to anyone who has an interest in a property in the UK. This means that spouses who jointly own a property are deemed to have an interest in that asset and, therefore, either party are subject to the 3% surcharge when buying a second property.   

Does the 3% surcharge apply to companies? 

As a limited company is considered to have legal status in its own right, it’s not unreasonable to think that a company should be exempt from stamp duty for the first property it buys.

Sadly, tax legislation is not always that straightforward.Companies are subject to the 3% surcharge from their first property investment regardless of the property ownership position of the company's shareholders.

Abolition of 10% wear and tear allowance 

Previously, there was a flat 10% tax allowance on rental of a furnished property, meaning that that landlords could claim a fixed 10% of gross rents against their rental profits, despite having spent money on refurbishment or not. The impact was substantial, especially for higher rate taxpayers.

For example, consider a portfolio generating rental income of £100,000 and profits after expenses of £80,000. The wear and tear allowance would have given an additional £8,000 expense to be offset against the rental profit. For a higher rate taxpayer this would be worth 40% of £8,000. 

On that basis the annual tax bill of a higher-rate taxpayer would have increased by £3,200 on the same amount of rental profit. That essentially reduces the gross rental yield earned from the portfolio by 3.2 percentage points. That has a dramatic impact on the return on investment.

The ability therefore to retain profits in the company and only pay tax at the lower corporate rates (currently 19% - but going up to 25% in 2023) is still one of the most compelling reasons to hold a property through a limited company. 

Removal of tax relief for mortgage interest 

Previously, landlords in the higher rate tax bracket with property in their own name could claim mortgage interest as a taxable expense. Since this allowance has been scrapped, landlords with a leveraged property portfolio have experienced a significant hike in income tax payable.

It also means that the expected return on investment or yield on the property also drops.

This should be taken into account when undertaking the appraisal for a new property purchase via leverage. This presents a compelling reason to switch towards ownership of property via a limited company (unless, of course, you purchase property without the need for finance).

What are the benefits of holding investment property in a limited company? 

There are four main benefits to holding property in a company: 

1. Ability to deduct mortgage interest in full 
2. Rental profits taxed at lower corporation tax rates (currently 19%, but going up to 25% - albeit with a reduction for smaller companies with less than £250k profits)
3. Flexible distribution of profits to shareholders 
4. Retention of profits for re-investment 

The main advantage is the ability of companies still to deduct mortgage interest in full against its rental profits, compared to the restriction for individuals holding property directly.  So for those landlords who have high debt-servicing costs or who are looking to expand their property portfolio through refinance and leverage, the company structure is more favourable. 

The other advantage of the company ownership route is the ability for the company to retain its profits. As the company is a separate legal entity, it pays tax on its own profits which are then available for distribution to the owners/shareholders. The shareholders can choose for their profits to stay in the company, meaning that the tax suffered on those profits is limited to the lower corporation tax rates compared to higher income tax rates.

The benefit of this is that the company then has extra cash funds available to reinvest in other properties to expand the portfolio further. This is highly advantageous to the landlord looking to grow the portfolio and minimise the amount of cash that is lost through tax. 

By contrast individuals holding property personally would pay tax at up to 45% whether or not they need use of the rental income for reinvestment. So whilst holding property in a company is useful for those looking to expand their portfolio, it may not suit those individuals who need an income from their properties.  This is a further consideration when determining whether the limited company route is right for you. 

Downsides of holding property through a company 

One of the main reasons why property was not typically held through a company before these changes was the potential double taxation that arises on sale of a property in the company and having access to the sale proceeds. 

As a company is its own legal entity, it pays corporation tax on profits and capital gains tax from disposals of assets. The company would be liable for corporation tax on the increase in value of the property from the time it was bought to the time it was sold.  Thereafter, if you wanted to withdraw that cash from the company for personal use, you would need to extract those funds via a dividend or salary etc. 

Finance for buy to let properties

In the past it has been more difficult to obtain finance for buy to let properties via a company. Lenders have preferred landlords to buy in their own name, as the landlord is effectively personally liable for any default. 

However, given the tax changes that have taken place and more and more landlords making the shift to holding properties via a company, lenders have had to adapt their credit policy and products to remain active and competitive. As such, there is no real difference now in the buy to let products available for individuals and companies. 

Contact Walji for expert property investment advice

If you are still unsure about what company structure is best for your property investment business, then Walji can help. You can book a strategic consultation which allows you access to our property tax expertise to answer any questions you have on your current portfolio and tax implications thereon. 

Click here to choose a convenient time and book.

Summary 

The introduction of punitive tax changes has made the proposition of buying properties through a limited company more favourable. Previously, the limited company route was not that popular and was mainly the preserve of larger property investors, mainly due to the double taxation charge on taking property out of the portfolio and inflexible buy to let mortgage products.   

However, with the changes, especially the removal of the wear and tear allowance and the phasing out of mortgage-interest relief, the limited company route has certainly become more appealing. 

In summary, the limited company route is without doubt the way to go for property investors who: 

• want to grow a portfolio 
• plan to retain a profit within the company in order to buy further properties 
• do not necessarily need all of the income and profit that the portfolio generates 

For those who still need income from properties to live on, then it may be worth doing some extra calculations to see if a limited company would be the most efficient route for you.