Why Do I Set Up a Limited Company for Buy-to-let Properties?

The recent years have been characterized by a significant transition toward purchasing investment properties through a limited company. In the UK, landlords have preferred to purchase investment properties via limited companies because of tax efficiency.

What is a limited company for buy-to-let?

UK landlords have two choices when it comes to purchasing investment properties. Landlords can either buy properties as an individual and thus pay income tax. Or, they can pay corporation tax if they purchase property through a limited company. Setting up a company for your buy-to-let portfolio will be considered an incorporation. 

Landlords in the UK who have bought investment properties through a limited company get their rental income differently. It is the company’s income. This implies that by setting up a limited company for your buy-to-let portfolio, you have the option of either taking your rental income in the form of dividends or taking salaries (on a monthly basis) from the company.

Why consider setting up a limited company for buy-to-let properties?

The transition to buying buy-to-let properties through a limited company is primarily because of modifications in the mortgage tax relief rules in the UK. From April 2020, mortgage expenses cannot be deducted from rental income for reducing tax bills This applies to private landlords in the UK. This change caused a significant reduction (as much as 40%) in the after-tax profits of landlords.

With a limited company, mortgage interest can be treated as a cost. Not only that, tax rates for dividends and corporation tax are significantly lower compared to the rate of income tax for higher rate taxpayers. Therefore, setting up a limited company is a decision that is being considered by private landlords in the UK.

Investment property purchases through a limited company: Advantages

●      As a landlord, purchasing investment properties via a limited company enables you to pay corporation tax. The rate for corporation tax is lower than that of individual income tax.

●      You don’t have to pay inheritance tax, capital gains tax, or stamp duty if you are going to be transferring a property from one company to another. This is another notable way in which you could reduce your expenses as a private landlord in the UK.

●      With a limited company, there is greater legal protection owing to limited liability. Limited liability means that the extent of your financial liability is restricted to the amount of money spent when your limited company was incorporated (in case anything unexpected or wrong happens).

●      The restrictions imposed on the mortgage interest tax relief for buy-to-let properties are not applicable to limited companies.

Investment property purchases through a limited company: Disadvantages

●      With a limited company, there will be added responsibilities such as filing returns and accounts.

●      landlords should appoint a specialist such as an accountant or broker which can increase your expenses.

●      There are costs associated with transitioning to a limited company. For instance, if you take profits from the company, you’ll be liable to pay income tax.

●      It can be more challenging to access a buy-to-let mortgage through a limited company. 

Income tax rate versus the corporation tax rate

●      Individual income tax rate (effective from April 2021) for buy-to-let properties:

○      20% for buy-to-let income ranging between ££12,571 and £50,270.

○      40% for buy-to-let income ranging between £50,271 to £150,000.

○      45% for buy-to-let income above £150,000.

●      The corporation tax rate for buy-to-let properties:

○      19% (since 2017)

○      Will become 25% (applicable to profits over £250,000) from April 2023.

Should you set up a limited company?

It is imperative to go through the steps of how to set up a limited company before deciding to do so. After that, the decision of whether a limited company is beneficial to you will depend on the following pointers:

●      If you’re purchasing a buy-to-let property for the first time and your goal to is rent out one or two of such properties, a limited company may be unnecessary. However, if your goal is to create a vast buy-to-let portfolio, a limited company is a good option.

●      The tax benefits associated with purchasing buy-to-let properties through a limited company are prominent for landlords who own several buy-to-let properties.

●      Before making this decision, calculate the costs involved in setting up a limited company (e.g.: stamp duty land tax, conveyancing, and legal fees, capital gains tax, increased mortgage costs, and early redemption charges). Weigh these costs against your tax savings.  

Before making this decision, it is also important to consult a tax accountant for tax advice regarding this decision if you are a landlord in the UK.