Should landlords incorporate to avoid the new Tenant Tax?

With mortgage interest relief being cut for buy-to-let investors in the UK, 4 in 10 landlords are considering forming a company to avoid what has been dubbed the “Tenant Tax”.

The rules, which were first announced in the 2015 Summer Budget, will reduce mortgage interest relief for individual residential landlords, with the reduction being phased in from April 2017.

As a result, four in 10 landlords are either seriously considering forming a limited company in order to limit their exposure to the charges, or will be looking into the option in the coming months, according to the National Landlords Association.

How will the changes affect you financially?

The changes will mean that landlords will no longer be able to deduct the cost of mortgage interest before declaring their taxable profit. In other words, they will be taxed on turnover.

While that may not sound dramatic, the laws will hit smaller landlords particularly hard. It will force many basic rate payers into a higher tax bracket and leave higher and additional-rate payers with considerably bigger tax bills.

Consider an example given by Hayley Bradfield, an Associate of Cardiff-based Watts Gregory Chartered Accountants.

Landlord tax example

Under the current rules, a landlord with a £375,000 home generating an income of £350 a week with a 75 per cent LTV mortgage would have a turnover of £18,200 a year. Allowing for £5,000 expenses, and deducting the mortgage interest of £9,140, the profit is £4,060, incurring a tax bill of £1,624 – and a final take-home sum of £2,436.

Under the new rules, the same landlord would not be able to deduct their mortgage interest, instead declaring £13,200 profit. Even taking into account the 20 per cent tax credit landlords would receive on their mortgage interest (£1,828), the final tax bill would be £3,582, taking the effective tax rate from 40 per cent to 80 per cent and cutting the take-home earnings from £2,436 down to £608.

Here’s an example of a landlord with a portfolio of 10 similar homes, who would end up paying more than 100 per cent tax, effectively leaving them making a loss of £4,450 every year.

Landlord tax example 2


Related: What is a good buy-to-let yield?

How does incorporation work?

Landlords structured as companies will be exempt from these changes. With the costs potentially proving very severe, it is no surprise that 40 per cent of landlords are now considering becoming companes instead. However, the NLA research found that so far only 1 per cent have actually incorporated, which the NLA attributes to the high cost of transferring property held personally into a company.

Incorporating would turn your buy-to-let property into a business, rather than an investment. You would be exempt from the tax on your rental income, but would instead pay corporation tax, which is currently 20 per cent, on the company profit.

While setting up a company is a relatively simple process, taking just 24 hours and £12 through the Companies House website, though, it becomes far more complex when assets such as real estate are involved.

Let’s take a look at some of the things you will have to consider, as part of turning your landlord activities into a business.

Buying the property from yourself

Because you are no longer the owner of the property personally, you will need to effectively buy the properties from yourself. It may be possible to do this by transferring your properties with their existing mortgages to the company, but it is not normally this straight-forward.

If not, you will have to pay off the existing mortgages and take out new mortgages. Mortgages are normally approved on different terms for companies and are subject to commercial, rather than personal, rates. This may mean that your mortgage payments could increase.

Paying taxes on the property

By selling the property, or properties, to a company, you would incur stamp duty land tax on the sale. You might also have to pay capital gains tax too. These are both before you have even begun to benefit from being exempt from the new tax rules. Stamp duty land tax is around 5 to 12 per cent, although this may be possible to be avoided in certain conditions.

Is your business a partnership?

If your business is a partnership, it is possible that you may be able to avoid stamp duty land tax. However, jointly-owning a business does not mean you are a partnership; seek legal advice to determine this.

Do you look after your properties yourself?

To be eligible for incorporation, you will need to carry out a reasonable level of hands-on activity in the management of your business. If you currently use a letting agent to take care of everything, you may need to do more.

What about other fees?

All of the above will likely incur fees for services used, whether that is from a mortgage lender, a solicitor, a letting agent, or other professionals.

What do you get from becoming a business?

Incorporation will primarily mean that you are exempt from the new mortgage interest rate relief rules. There is, of course, no guarantee that the government will not change the rules in the future to include incorporated landlords. For now, though, you will benefit from a lower tax rate of 20 per cent on company profit and will be able to earn money by withdrawing dividends or paying yourself a salary – although both of these can incur personal taxes.

If your company sells the property, you may be eligible for CGT uplift, effectively deferring your capital gains tax bill.

You will also be better financially protected; if the company goes into debt, you will normally not be responsible.

Is incorporation right for you?

This is only a brief guide to the things that you will need to take into account, should you decide to incorporate, and is by no means exhaustive – we highly recommend seeking legal and financial advice before making this decision, to ensure that you are informed and up-to-date with the current law as possible.

With the mortgage interest rate relief rules being phased in from April 2017, though, you have lots of time to consider whether becoming a limited company would be worthwhile for you. At present, 31 per cent of landlords have no intention of moving their portfolio to a limited company, according to the NLA, and 29 per cent are still unsure about whether they will or not.

Richard Lambert, Chief Executive Officer at the NLA, says: “Transferring personally held property to a limited company isn’t a straightforward process, so it’s not surprising that so few have taken this action so far.

“Landlords need to do their research but many will realise that incorporating simply doesn’t stack up financially; doing so will incur capital gains and potential stamp duty charges, which means the process may be prohibitively expensive.”

What else can I do?

With the tax changes still going ahead, you can help to campaign for a U-turn by the government, or for a judicial review of the Finance Act 2015, which contains the new law. To support the Axe the Tenant Tax campaign, click here for more information.