Why Landlords are about to become Ltd Companies

When the bells strike midnight on Dec 31, there will be many landlords out there aware the clock is ticking away on tax relief on their buy-to-let mortgages.

Because from 2020 George Osborne’s radical new laws will force property investors to pay interest on the total rental income they receive from a property, rather than just currently the profits.

In a shock move announced in the summer this year, landlords learned this will amount to 20 per cent tax across the board (ie regardless of tax bracket). This means that middle and higher income investors will be worst hit since they’ll lose the 40 per cent and 45 per cent tax relief they currently enjoy, in addition to having to pay tax on what is effectively the cost of their buy-to-let mortgage.

For many property investors it could mean having to pay twice as much tax than at present (by tipping lower income tax payers into the higher income bracket). For others it would mean making no profit at all or worse, making a loss (those whose mortgage costs are more than 75 per cent of their rental income). Landlords in London, where yields are low, will be one of the worst hit. However, the super rich ie those who have no mortgage on a rented property, won’t be affected at all.

Nearly 41,000 individuals have signed a petition asking the government to rethink the proposed ban on tax relief for buy-to-let. Many landlords are already considering selling while others are proposing to refurbish and increase rents. Many are desperately attempting to remortgage at a lower rate.


Case study

Garry Johnstone, 32, from Liverpool is a landlord and full-time teacher with one buy-to let who is on a lower tax bracket. The rental income from his buy-to-let is £20,000 a year and his mortgage costs £16,000. He currently pays 20 per cent tax on the rental income minus the cost of the mortgage ie £4000, resulting in £800 tax and £3,200 profit.

After 2017 he will have to pay 20 per cent tax on the entire rental income of £20,000, resulting in tax of £4000 and no profit at all. In fact he will be operating at a loss since he also has £40 letting agency fees to pay, puts £400 away for repairs and maintenance every year and pays £150 annually in insurance.


Limited Companies – a way out

But it’s not all doom and gloom – not according to accountants who insist that for some middle income buy-to-let landlords (those in the 40 per cent and above tax bracket and with larger property portfolios of 10 or more properties) the way to dodge the worst of the tax relief ban would be to operate as a company rather than an individual.

This is because the income from their rental properties would be charged at a corporate rate rather than a personal one and the former does benefit from tax relief. Not only that, but as an added incentive, corporate tax is due to reduce from 20 per cent to 18 per cent by 2020.

There will be initial costs to look out for though. That includes stamp duty and capital gains tax (up to 28 per cent) on each individual property which is transferred into ‘company’ status. Then there are the annual costs of running a company ie filling in an annual return and hiring an accountant.

Also, withdrawing money from the company would be best done via dividends. Although in a ‘give with one hand and take with the other’ type move, dividends will be subject to charges from next year: 7.5 per cent for basic rate taxpayers, 32.5 for higher and 38.1 for the additional rate tax band. A tax free dividend allowance will be capped at £5,000 – prompting many accountants to advise that landlords use the company as a future pension pot rather than an income source. So, for many landlords, no change there then…

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