Is it worth converting your buy to let business into a limited company ahead of April's tax changes?
Head of Property Litigation, Mike Lewis and Corporate Solicitor Vanessa Crawley explain the benefits and potential pitfalls of switching your buy-to-let business to a limited company ahead of April's tax changes.
Purchasing a buy-to-let property to generate additional income is a popular way of holding an investment.
Individuals are currently able to offset their mortgage payments against the rental income. However, from April 2017, the tax relief will be less favourable for higher rate tax payers. As a result, many individuals are looking to operate their rental properties through a limited company. So what are the points to consider in doing so? Using a limited company is one of the most popular methods of running a business. Even though operating as a sole trader is just as common, a limited company model can be advantageous.
Advantages of converting your buy to let business into a limited company ahead of April's tax changes
A limited company forms a completely separate entity to you as its owner. From a legal perspective, this means that business contracts are created between a third party and a limited company, instead of the individual directors. This may protect personal assets and finances of the owners of the company, in case things go wrong. If a limited company is not able to pay its debts, its owners will not be liable for financial losses, providing that no fraud took place. Operating as a sole trader does not confer this benefit. Additionally, any advances made to a limited company, such as a mortgage deposit, can be drawn back out by means of a directors loan- a tax efficient way to manage financial affairs.
A limited company also attracts a professional image, which can boost the value of any business, as others will be more likely to perceive it as well- established and credible. This can make a significant difference when securing new contracts.
Certain tax benefits and reliefs which are not available to sole traders can be utilised by limited companies. For example, when business profits are reinvested to secure further properties, income tax may not be payable on that sum. This allows buy to let landlords to expand their portfolio and grow the business quicker. However, this benefit can be contrasted with a lack of capital gains tax allowance, which is available to sole traders. These points are likely to become even more important in light of the upcoming tax changes in April 2017.
Additionally, the recent changes to Stamp Duty charges have also affected the way landlords buy properties. The 3% increase in Stamp Duty on purchase of a second property has pushed many landlords to place their property portfolio in a limited company to offset the impact of the changes. However, the new law will also apply to limited companies. The corporation tax payable may be lower than income tax chargeable on profits, especially for higher rate tax payers but purchasing as a company may limit the number of mortgage options available. To combat these changes, the government is planning to decrease corporation tax to 19% in 2018 and 18% in 2020.
Potential pitfalls of converting your buy to let business into a limited company ahead of April's tax changes
One of the main potential pitfalls of becoming a limited company is that transferring the existing properties from your name to a limited company may attract stamp duty, which could be substantial.
Also, forming a limited company will require more attention from you. The administrative burden will be far greater than that of a sole trader and a limited company has its own filing requirements set out by Companies House, which must be adhered to. Of course, this work can be outsourced to an accountancy firm, but this will increase running costs.
Making the decision
In the light of the above comments, before making a decision, you must weigh up the advantages and disadvantages of setting up a limited company to run your buy to let business. A variety of circumstances will play a role when deciding whether or not this is an appropriate model for you. The benefits offered by running a limited company seem appealing, but before changing your investment strategy consult an accountant to discuss financial matters that may affect your decision.