Following the phasing in of section 24 of the Finance (No2) Act 2015 in April 2017, one of the biggest quests undertaken by portfolio landlords has been to work out how to reduce their tax bill. Those new to the landlord business frequently ask us at Martin & Co Camberley:'How much tax do I pay as a landlord?'
Up until April 2017, that was a reasonably straightforward question to answer. Landlords could deduct the full cost of their buy-to-let mortgage interest payments before paying any tax.
But with section 24 now in place, many landlords have been, and still are, pondering their next move. One option for landlords is to place their property portfolios into a limited company, meaning they pay corporation tax (currently 19% of profit) rather than income tax. With many landlords forced into a higher tax bracket by the effects of section 24, this could represent a significant saving.
At Martin & Co Camberley, we've been weighing up the pros and cons of incorporation, but strongly advise that landlords take independent advice from tax professionals before deciding whether or not to form a limited company for their portfolios.
HOW WILL SECTION 24 AFFECT ME?
The phased effect of section 24 could force many landlords into a higher tax bracket despite their income not actually increasing, Without the ability to deduct mortgage interest from their income, HMRC will see more 'profit' as taxable.
In cases where the increased 'profit' places a landlord into a higher tax bracket, some could end up renting at a loss.
HOW IS IT PHASED?
In the first year of section 24, between April 2017 and April of this year, landlords could claim tax relief on 75% of their mortgage interest costs, but now we are in the 2018-19 tax year, only 50% can be claimed.
From April 2019 to April 2020 only 25% can be claimed, while from April 2020, 100% of mortgage interest will be subject to the basic 20% income tax rate.
WHO WILL BE AFFECTED MOST?
Landlords with high loan to value portfolios could feel the pinch more than most. Those sitting in the 40%-45% higher tax brackets will pay more tax under the section 24 legislation, while those just underneath it could see their 'new income' push them into those higher brackets.
OKAY, SO WHAT ARE THE BENEFITS OF INCORPORATION?
The main benefit of placing your property portfolio into a limited company is seeing your tax return change from income tax to corporation tax.
Corporation tax is currently 19% of company profits, while it is set to drop to 17% from April 2020.
It is paid once a year and based on calculated profits, while income tax, whatever the bracket, is payable twice in January and July, based on estimated profits.
Moreover, capital gains on rental properties would be charged at the corporation tax rate.
...AND WHAT ARE THE NEGATIVES?
Of course, corporation tax, as attractive as it is currently, could go up. Nothing is certain and once mortgage interest relief is fully phased out by 2020, the political landscape could be quite different.
There is always an element of guesswork when it comes to government taxation and while corporation tax rates are attractive currently, in 18 months' time things could be quite different.
One thing landlords pondering incorporation also need to be mindful of is the increased workload.
A limited company has to submit formal accounts with Companies House and tax returns can take longer to complete, while the scrutiny on company accounts is intense to say the least.
Landlords incorporating would need to be confident their finances were sound enough to stand up to an increase in perusal.
While corporation tax is more attractive than even basic rate income tax, landlords drawing profits from their newly-formed limited company still have to pay personal tax on these dividends.
While there is more flexibility on tax efficiency when it comes to dividends, landlords would need to ensure they have enough money to cover their income tax liability as drawing more money from their companies to meet this requirement would result in more tax needing to be paid.
REMEMBER, EVERYONE IS DIFFERENT
Martin & Co Camberley cannot stress enough how important it is for landlords thinking of incorporating to seek independent financial and tax advice.
The specific personal and financial circumstances of every landlord are almost certainly going to be different and while incorporation may be right for one, it could be completely the wrong move for another.