Residential Properties – Company or personal ownership?

We are often asked, is it better to own properties personally or via a company and often individuals have a preconceived idea that, nowadays, companies are always the most tax efficient structure. This preconception is often driven by YouTube videos or social media. The truth, however, is that there is no simple answer to the question; with the answer being driven by the individual’s personal circumstances, future intention and their ‘end game’.

In deciding the best structure for an individual’s personal circumstances, there are various factors that must be considered.

Tax efficiency:

Profits derived from personally owned properties are subject to income tax on the individual. Where the profits fall at basic rate, tax is 20%, with this increasing to 40% at higher rate and 45% at additional rate.

Profits are calculated by deducting the rental expenses, exclusive of mortgage interest, from the rents received. These profits are then taxed. Once the tax figure is established, this is reduced by 20% of the mortgage interest suffered, in effect restricting mortgage interest relief to the basic rate of tax.

Profits realised within a company are subject to Corporation Tax at a rate ranging from 19% to 25%, dependent upon the level of profits realised in the year. Mortgage interest is deducted in full in calculating a company’s profits that are subject to tax.

For basic rate taxpayers, the tax suffered on rental profits are broadly similar, regardless of the structure in which the properties are hold. For higher rate taxpayers, a company structure can offer significant tax savings. It must be noted however, that should the company owner want to access the profits personally, the Corporation Tax suffered is only half the story, with further tax charged on the individual when extracting the profits from the company.

Access to profits:

Where properties are held individually, the net profits from the rents, after tax has been paid, belongs to the property owner to use as they wish. This is in stark contrast to a company. Where the properties are owned within a corporate structure, the profits after tax belong to that company, being a separate legal entity in its own right. Should the owners of the company need the profits personally, they must be extracted by way of a salary or dividends. This then adds a second layer of tax, with income tax arising on the funds extracted by the business owner after the company has already suffered tax on the profits.

Where the funds are the be retained within the company to either pay down borrowing or fund future acquisitions, the second layer of tax is avoided. Likewise, the company can make pension contributions on the behalf of the owner, benefitting from a company tax saving on the additional expense.

Future Intentions:

Many people begin investing in property whilst working, with a view to being able to give up work and have the property portfolio support them moving forward. Therefore, it may be the case than an individual is a higher rate taxpayer at the start of their property journey, however they have an intention for this to change in the short to medium term. As such, the most tax efficient structure on day one may not be the most tax efficient structure over the life of the business due to changing circumstance. A balanced view at the offset of the business is required to decide what is best.

Other Considerations:

Assuming the properties are to be mortgaged, there is still a differential in the rates available to individuals and to companies, with buy to let mortgage available to individuals generally being at more competitive rates than those available to companies.

There is also a significant difference in the compliance burden and red tape of the two different structures. The reporting of the profits is generally much simpler for individuals than for companies, with the income and expenses reported directly on to the individuals tax return. Companies are required to prepare full formal accounts. The company accounts must be filed annually at companies house, with company tax returns also submitted adding to the compliance burden of corporate ownership. Furthermore, should the funds need to be extracted from the company, there could be the requirement to set up and maintain a PAYE scheme to facilitate a salary being paid.

Changing Structures:

Switching from owning properties personally to owning via a company can, in most situations, be an expensive exercise with the individual incurring capital gains tax on the ‘sale’ of the properties to the company and the company incurring Stamp Duty Land Tax on the market value of the properties transferred. These liabilities can arise regardless of whether the properties are sold or gifted by the individual owner to their company.

Likewise, extracting properties from a company into personal ownership comes with similar prohibitive tax charges, making structing affairs correctly at the outset vitally important.

Summary:

Given the number of factors involved in making the right decision and the potential costs involved in rectifying inefficient structures, it is essential full consideration is made at the outset as to what is best for the individual taxpayer in their own circumstances.

In summary, for basic rate taxpayers there is little advantage to a company structure, as there is no tangible tax saving available and the added overheads and compliance eat into the profit available. For higher rate taxpayers the decision is much more finely balanced and to establish the best structure, consideration is needed regarding the current and future intention.

At Wright Vigar we offer individually tailored advice to support our clients in ensuring their tax affairs are structure with today and tomorrow in mind.