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Successful landlords are always on the lookout for ways to minimise operational costs and maximise rental income. One of their biggest grumbles is often tax, which can take a big bite out of their profits if they don’t take steps to enhance tax efficiency.
This is why forming a limited company has become an increasingly attractive option for landlords. By doing so, some landlords are able to reduce their tax bills and retain more of their earnings. According to estate agents Hamptons, a record number of landlords set up limited companies for their buy-to-lets in 2023.
So, what is causing this trend, and should you jump on the bandwagon? In this article, we’ll explain why some landlords set up limited companies for their rentals and how they benefit from doing so. Once you understand the pros and cons of this strategy, you can make an informed decision about whether setting up a limited company is the right option for you.
What is a limited company?
A limited company is a type of business structure where the company is legally separate from its owners.
Private landlords own their properties in their name. However, if you set up a limited company for your rental property, you then own shares in the company, and the company is the legal owner of the property.
Why have more landlords started setting up limited companies?
The number of landlords setting up limited companies has been increasing since 2017, when the government began phasing out tax relief on mortgage interest for private landlords.
Before 2017, private landlords could offset their mortgage interest payments from their rental income before tax to reduce their tax bill. The government announced it was scrapping this initiative and instead gave private landlords a 20% tax credit. The changes meant that many private landlords, particularly higher-rate taxpayers, saw their tax bills rise significantly.
In response, many landlords set up limited companies for their rental properties to help reduce their tax liability. Research by Hamptons found that over 50,000 buy-to-let limited companies were formed in 2023, compared to just 19,000 in 2016.
What are the benefits of setting up a limited company for rental property?
Before setting up a limited company, it’s important to be well-informed about all the pros and cons of this strategy. Let’s start with the good bits.
Claim tax relief on mortgage interest
As we’ve just learned, the main reason why so many landlords are now setting up limited companies for their rental properties is to claim tax relief on mortgage interest. This may be one of the top reasons landlords go down this route, but it’s far from the only benefit. Let’s learn about some of the other advantages of this strategy.
Reduce tax bill
If you set up a limited company for your rental property, you will pay corporation tax on profits rather than income tax. Corporation tax ranges from 19% to 25%. This is a significant improvement on the 40% or 45% that many landlords on the higher tax rate are used to paying.
Limited liability
Renting out property through a limited company provides better financial and legal protection. As a shareholder of a limited company, if your rental business were to run into financial difficulties, then you would not be personally liable for these debts. This protects your personal assets like your house or car. However, as a sole trader, your personal assets would be fair game.
No income tax on retained profits
Any profits that remain in your limited company are not subject to personal tax. This allows you to build up savings faster to reinvest and grow your portfolio.
What are the drawbacks of setting up a limited company for rental property?
While there are many attractive benefits of creating a limited company, there are also significant drawbacks. Carefully weighing the good and the bad will help you decide if this strategy is right for you.
Tax on money you pay yourself
Although you may benefit from tax relief on mortgage interest and enjoy lower corporation tax rates, you will need to pay personal income tax on any money you pay yourself as a salary or dividends.
Reduced access to funds
As a sole trader, any profits you earn land straight in your bank account and can be accessed immediately. It’s a little more complicated accessing your funds as a limited company as the profits belong to the business. To access them, you’ll need to either pay yourself a salary or declare dividends.
Harder to obtain a mortgage
Limited companies generally have fewer mortgage options than individuals. Mortgages for limited companies usually have stricter lending criteria, higher interest rates, and less favourable terms.
Costs of transferring properties into the company
If you’re setting up as a limited company retrospectively, you will need to sell each of your existing properties to your new limited company. In addition to paying capital gains tax when you sell the property, your limited company will also need to pay stamp duty on the purchase. On top of tax, you may also need to pay an early repayment fee if you’re switching your mortgage and legal fees to transfer the property.
Increased administrative burden
Running a limited company comes with its own responsibilities and statutory requirements and can involve significantly more paperwork than operating as a private landlord. You will need to register with Companies House, keep accurate and up-to-date accounts, file annual accounts, submit a company tax return, and more. Generally, managing the accounts for a limited company is more time-consuming and complex than submitting a personal tax return.
No capital gains tax allowance on property sales
Sole traders receive a tax-free capital gains allowance when selling property, but limited companies are not entitled to this allowance. Instead, they pay corporation tax on the full amount of any capital gains, which could result in a higher tax bill when selling a property.
Tax on equity release
When you release equity as a limited company, those funds belong to the company. If you want to use them personally, they will be classed as income and taxed appropriately.
Is setting up a limited company the right move for you?
Armed with the facts, it’s now time to decide whether setting up a limited company is the right move for you.
This decision will depend largely on the size of your property portfolio, your individual circumstances, and your long-term financial goals.
While it’s true that setting up a limited company can offer significant tax advantages and legal protection, it also incurs its own set of expenses and can be a more complex way of operating, requiring more time and management.
Generally, setting up as a limited company is more worthwhile for landlords who are higher-rate taxpayers and who own multiple properties. Often, those who are basic tax-rate taxpayers or only own one or two properties find that the savings do not outweigh the added responsibilities associated with running a limited company.
However, if, after crunching the numbers, you’re still unsure which route to take, you may benefit from speaking to a financial advisor or tax specialist. They can help you evaluate the potential benefits of creating a limited company and come to an informed decision.
How to set up a limited company
If you decide that operating as a limited company is the way to go, getting set up isn’t too difficult. The process can be roughly divided into six steps.
- Choose a name for your company
- Appoint directors and shareholders
- Allocate shares
- Prepare Memorandum and Articles of Association
- Register with Companies House
- Register for Corporation Tax
The Government website walks you through the process step-by-step.
What other steps can landlords take to be more tax efficient?
Forming a limited company may or may not help to reduce your tax bill, but it’s not the only strategy used by landlords to improve their tax efficiency.
So, if you don’t think forming a limited company is for you, perhaps you can improve your tax efficiency elsewhere.
Let’s explore some other effective ways to cut your tax bill.
- Claim all allowable expenses – As a landlord, you can deduct several allowable expenses from your income before working out your tax liability. Keeping track of these expenses and making sure you claim them all can help to reduce your tax bill. Allowable expenses include things like property repairs and maintenance costs, letting agent fees, insurance, utility bills, and accountancy fees.
- Consider joint ownership – If you and your spouse own rental property jointly, you can split the income equally to share the tax burden. If one of you is in a lower tax bracket, this will help reduce your overall tax liability.
- Claim Principal Private Residence Relief – If you’ve lived in a property as your main home before renting it out, you can potentially claim Principal Private Residence Relief when selling it. This relief reduces the amount of Capital Gains Tax (CGT) owed on any profit made from the sale of the property.
- Use the Property Income Allowance – The Property Income Allowance allows landlords to earn up to £1,000 of rental income tax-free each tax year.
- Claim capital allowances – Landlords can also reduce taxable profits and lower tax liability by ensuring that they claim deductions for certain capital expenditures, including furniture, fixtures, and equipment for their rental properties.
Want to learn more? Read our blog to discover more simple property tax tips.
Ultimately, becoming tax efficient is crucial for landlords who want to maximise their profitability and grow their rental business. Setting up a limited company may be a popular strategy for achieving tax efficiency, but it’s not the best option for everyone. While there is the potential to make tax savings on mortgage interest and corporation tax, the additional responsibilities and costs associated with managing a limited company should not be overlooked. Ultimately, the best approach for you depends on your unique circumstances, goals, and portfolio size. Even if a limited company isn’t right for you, there are still plenty of other ways to reduce your tax bill and increase your profits as a landlord.
