Tax changes in recent years to the way that unincorporated landlords are treated for tax purposes, particular in respect to relief for interest, have resulted in an increase in the number of landlords operating their property rental business through a company. Is this a good idea?
We take a look at some of the issue to consider in reaching a decision.
Separate legal identity
A company has a separate legal identity to those who own it. A company must be registered at Companies House and must file annual accounts and an annual confirmation statement. The individuals behind the company must extract any profits if they wish to use them personally, and this may have a tax cost.
Incorporating an existing business
If the landlord already has an unincorporated property rental business, he or she may simply choose to incorporate it. However, SDLT will be payable again (having already by paid on initial purchase by landlord); and as the company is connected to the landlord, this will be on the market value of the property, and for a residential property at the additional property rates as the 3% supplement applies regardless of the number of residential properties that the company has.
Transferring the property to a company may also trigger a capital gains bill on the landlord personally, again based on the market value of the property. However, where the landlord receives shares in exchange for the business, incorporation relief may be available deferring the gain until the shares are sold.
Setting up a new company
If the property company is set up from scratch and the property is brought by the company, this will avoid a double SDLT charge. If the property is a residential property, the 3% supplement will apply, even if the company only owns one property.
Tax on rental profits
A company will pay corporation tax on any rental profits. For the financial year 2022, this is at the rate of 19%, which is lower than the basic rate of tax. However, unlike an individual, a company does not have a personal allowance, and tax is payable from the first £1 of profit.
Also, from 1 April 2023, the rate of corporation tax for a stand-alone company rises above 19% where profits exceed £50,000. The rate will be 25% where profits are more than £250,000 and between 19% and 25% where profits are between £50,000 and £250,000.
Interest and finance costs
For residential lets (but not furnished holiday lettings) unincorporated landlords cannot deduct interest and finance costs. Instead, their tax bill on the rental profit is reduced by 20% of the interest and finance costs, regardless of their marginal rate of tax. The restriction does not apply to companies, who can deduct residential interest and finance costs in full in computing the taxable rental profit.
Once tax has been paid by an unincorporated property business, the landlord can use the after-tax profits for personal use without further tax liabilities. However, as a company is a separate legal identity, if the landlord wishes to use the profits personally, these must be extracted. This can be done in various ways, such as the payment of a salary or bonus or by declaring a dividend, and there may be additional tax and National Insurance to pay on top of the corporation tax paid by the company.
Sale of the property
If an unincorporated landlord sells a residential let realising a chargeable gain, capital gains tax will be payable at the residential property rates. Where income and gains fall within the basic rate band, this is at 18% and where they exceed it, this is at 28%. The landlord can use any available annual exempt amount (set at £12,300 for 2022/23) to shelter the gain. Residential property gains must be reported to HMRC within 60 days of completion and the tax on the gain paid within the same window.
Where the gain is made by the company, it will be liable to corporation tax on chargeable gains (at the rate of 19% for the financial year 2022, and between 19% and 25% from 1 April 2023 depending on the level of profits). The company does not have an annual exempt amount to set against the gain.