0800 140 4644
Nearly £1 trillion worth of housing in the UK is held as second homes by individuals or businesses and people are increasingly putting money into second properties, especially with a relaxing in the Pension rules.
One of the most frequently asked questions we get from clients is “What structure should I use for my Property Business?” i.e., if you have a buy-to-let property, or rental property business, should you hold it personally, hold it jointly with your partner (Partnership), through a Limited Liability Partnership, Investment Company, through a Pension Fund, or Trust.
This has increasingly come up in conversations about tax requirements since the restriction of interest deductibility for individuals with property businesses.
A guide to business structures
Sole Trader
As well as being the simplest (the property is in your personal name), most flexible (selling the property and realising the cash) and cheapest (both in terms of potential Accountants fees and lending costs), the Capital Gains Tax rate upon selling the property is also comparatively low at 2019/20: 18/28% (depending on your tax band), with the gain calculated as the proceeds from the house, less what you paid for the property and the annual exemption (2019/20: £12,000). If it is your only Property, you will also not pay the additional 3% Stamp Duty Land Tax (‘SDLT’) rate.
However, if you are a higher rate tax payer, you will pay 40%/45% (2019/20) on any income received from the property income each year, there is no limitation of liability, so you could lose everything you own if there are funding issues. Up until 2020 the level of deductibility of interest arising from mortgage interest is being reduced, meaning ceteris paribus, the taxable profit will increase. Additionally, the property(ies) will constitute part of the individuals’ estate and whilst this limit is increasing for a spouse and their partner to £1m by 2020, any excess is taxed at 40% (2019/20) upon the death of the surviving spouse. The additional 3% of SDLT will also apply if you’ll own more than one residential property as a result.
Partnership
Very similar to sole traders, the benefit of Partnerships over Sole Traders is you will have the annual exemption for each partner and potentially pay lower income tax as you will have more tax bands to fill up for the partners before you pay the 40%/45% potentially (2019/20).
One of the first steps to reducing your tax liability could be to add your partner, wife or husband onto the deeds of the property. They can also be used as an interim structure before a portfolio of properties are transferred into an Investment Company (more below).
Both Sole Traders and Partnerships suit a strategy of short-term property ownership with a view to making a capital gain, or very small portfolios where individuals taxed at basic rate.
Limited Liability Partnerships (‘LLPs’)
These are very similar to Partnerships, but they have the added benefit of limiting the liability of any Partners/Members to what assets they have left in the LLP. They are however more complicated, and the Accountant costs are likely to be higher as a result.
Limited Company
A limited company, broadly speaking, is a legal structure for a business in which the liability of each shareholder is limited to their individual investment – this is known as limited liability.
In the UK, limited companies are governed by the rules and regulations contained in the Companies Act 2006, and all company registration and records are managed by Companies House.
This is the one where there is often the most interest, but unfortunately one where the answer is often not simple.
Here are the levels of tax on rental income: (2019/20: 19% Corporation Tax versus up to 45% on income tax), if you have funding issues you could protect your personal assets due to limitation of liability and the distribution of shares can be a simpler and fairer way to give away your assets especially where there are properties in different locations, with different values.
Selling the company as a whole, rather than as individual properties, can also lead to a higher selling price overall upon disposal and lower SDLT (2019/20: 0.5% versus up to 15%). If you retain any profits and reinvest these, it may also reduce the tax you pay and accelerate the growth of your property portfolio.
However, lending is often harder to achieve and more expensive. Shares in a limited company form part of an individual’s estate for Inheritance Tax (‘IHT’) purposes, Accountancy fees are often higher than sole trades and partnerships (although potentially lower than LLPs) and Entrepreneurs’ Relief is not available upon the sale of properties / company as it is not a trading business.
Limited Companies tend to be suited if the strategy of the business is long-term retention of properties, with lower taxes meaning higher profits to make further acquisitions to grow the portfolio.
Pension Funds
Not only are Pension Funds potentially very tax efficient, they also help ensure that you have income and capital available for retirement. However, there are a lot of rules as to what Pension Funds can and cannot own (i.e., typically just commercial properties, which generally have a lower rental yield and therefore return on the investment), and there can be issues for inheritees.
Often used where there is a significant portfolio of investments whose capital and income, owners want to enjoy in retirement.
Trusts
There are several different types of Trusts, but they are principally used to remove the property(ies) from the Estate for IHT. These are however special vehicles and as a result they are complicated, expensive to set up and depending on type you may have restrictions on what you can and can’t do with the capital and income.
Used where the focus is around IHT planning and the current investors have no direct/immediate need for the funds.
Our Property Business Recommendation
Whilst each scenario is unique and needs to be considered in detail, the overall recommendation will depend upon the overall strategy on the property portfolio. Start with the end in mind and the structure will determine itself.
For example, if you want to hold one or two properties for short/medium-term, it could be beneficial to suffer the higher rates of income tax on the rental income, for the lower rates of capital gain upon disposal, which would suggest a sole trade or partnership could work best. Whereas if you want to build a larger portfolio of properties for the longer-term and reinvest any proceeds made, a limited company may be preferred. If you have specific requirements however, other structures, such as Pensions and Trusts could be considered.
The answer may also be different if it is to be set up versus is an existing business, as changes in the structure of an existing business may attract SDLT if careful thought is not given. This cost needs to be considered in the cost-benefit analysis.
Tax Rates & Allowances
The rates and allowances discussed here all relate to 2019/20. If you want to see what these rates are for other years, please see our handy Resources section.
Undeclared Property Income?
If you receive rental income historically as an individual (sole trade or partnership) but didn’t declare it to HMRC, there is still the opportunity to do so under the Let Property Campaign. You can read more about this in our blog.
Contact us today
As mentioned above, every scenario is unique. If you would like us to model your scenario, to establish which would be the best for you, or you have any other questions relating to this, contact Black and White Chartered Certified Accountants today, or call us on 0800 140 4644.
