Tax Benefits and Pitfalls of Buying Property Through a Limited Company

In recent years, the trend of buying properties through a limited company has grown and has become very popular among landlords and property investors. 

This trend is especially appealing to people who want to optimise their tax position and build an expandable property portfolio. Even though using this process can be beneficial, one can not completely ignore the complications of tax implications as they require careful planning to ensure long-term profitability.

It is essential that you have a good understanding of all the tax advantages, such as:

• Lower corporation tax rates
• Mortgage interest deductibles
• Inheritance tax planning

It is also equality important to be aware of all the potential drawbacks that come with following this trend:

• Higher mortgage rates 
• Additional compliance costs
• Challenges of profit extraction

This article is designed for landlords, property investors, and business owners who are considering purchasing property through a limited company. 

Whether you’re a small-scale landlord or a seasoned investor, this guide will help you weigh the pros and cons, navigate the tax landscape, and make informed decisions that align with your financial goals.

The Tax Benefits of Buying Property Through a Limited Company

1. Corporation Tax vs. Income Tax

One of the most compelling reasons to buy a property through a limited company is the difference in tax rates. As of 2023, the corporation tax rate is

• 25% for profits over £250,000
• 19% rate for profits up to £50,000 and
• A tapered rate for profits between £50,000 and £250,000.

This means that there are significantly more savings for higher and additional-rate taxpayers. For example, if a landlord earns £100,000 in rental income, they could pay up to 45% in income tax as an individual, compared to 25% corporation tax if the property is held in a limited company. Over time, these savings can be substantial, especially for landlords with larger portfolios.

Read more on corporation tax

2. Mortgage Interest Deductibility

Since April 2020, individual landlords have faced restrictions on mortgage interest relief, which is now limited to a basic rate tax credit (20%). This has significantly reduced the tax efficiency of buy-to-let investments for higher-rate taxpayers.

As compared to individual landlords, limited companies can still claim full tax relief on mortgage interest as a legitimate business expense. 

This means that the entire interest payment can be deducted from rental income before calculating the taxable profits. Landlords that have large mortgages, can have considerable tax savings due to this tax relief system.

For example, if a property generates £30,000 in rental income and has £10,000 in mortgage interest, a limited company would only pay tax on £20,000, whereas an individual landlord would pay tax on the full £30,000 (with only a 20% credit on the interest).

Read more on Mortgage Interest

3. Dividend Strategy

Profits retained within a limited company can be distributed to shareholders as dividends, which may be taxed at a lower rate as compared to personal income. The current dividend tax rates are:

• 8.75% for basic-rate taxpayers
• 33.75% for higher-rate taxpayers
• 39.35% for additional-rate taxpay

This allows investors to optimise their tax liabilities by choosing when and how much to withdraw from the company.

For example, a landlord could retain profits within the company to reinvest in additional properties, only withdrawing dividends when they fall into a lower tax bracket.

This flexibility is particularly beneficial for investors looking to grow their portfolios while minimising their personal tax burden.

4. Inheritance Tax Planning

Holding property within a limited company can simplify inheritance tax (IHT) planning. Instead of transferring property directly, which may trigger IHT at 40%, one can also pass down the shares in the company to their immediate heirs.

This approach offers several advantages:

• Shares in a company may qualify for Business Relief, potentially reducing the IHT liability to 0% after two years of ownership.
• Transferring shares is often simpler and less costly than transferring property, as it avoids the need for re-registration or additional legal fees.
• Family members can be gradually introduced as shareholders, which allows for a smoother succession planning.

For landlords with significant property portfolios, this can be a highly effective way to preserve wealth for future generations.

5. Capital Gains Tax Efficiency

When selling a property, limited companies pay corporation tax on gains, which is typically lower than personal capital gains tax (CGT) rates. As of 2023, the corporation tax rate on gains is 25% (or 19% for profits up to £50,000), compared to personal CGT rates of 18% or 28% for residential property.

Additionally, limited companies can reinvest profits into new properties without triggering immediate tax liabilities. This allows them to have greater flexibility in portfolio growth and long-term planning. 

For example, if a company sells a property for a £100,000 profit, it can reinvest the proceeds into another property, which will allow the company to defer the tax liability until profits are extracted as dividends.

Potential Pitfalls and Tax Drawbacks

While buying property through a limited company offers significant tax advantages, it’s not without its challenges. Here’s a detailed look at the potential drawbacks and tax pitfalls to consider:

1. Higher Mortgage Rates

Limited company mortgages often come with higher interest rates compared to personal buy-to-let loans. Lenders view limited companies as higher risk, which can result in interest rates being 1-2% higher than those offered to individual landlords.

For example, if a personal buy-to-let mortgage has an interest rate of 4%, a limited company mortgage might have a rate of 5-6%. Over the life of the loan, this can significantly increase the borrowing costs and reduce the overall profitability, particularly for landlords with smaller portfolios.

Additionally, limited company mortgages may have fewer product options and stricter lending criteria, such as requiring larger deposits or higher rental coverage ratios.

2. Additional Tax on Profit Extraction

While retaining profits within a limited company can be tax-efficient, extracting those profits personally can lead to additional tax liabilities. Profits are typically withdrawn as dividends, which are subject to dividend tax rates as stated above in the Dividend Strategy.

This creates a potential double taxation scenario: the company first pays corporation tax on its profits, and then shareholders pay dividend tax on the distributions.

For example, if a company earns £50,000 in profit, it would pay £12,500 in corporation tax (25%), while leaving £37,500. If this amount is distributed as dividends to a higher-rate taxpayer, they would pay 33.75% dividend tax, resulting in an additional £12,656 in tax.

This means the effective tax rate on profits can be higher than expected, reducing the overall tax efficiency of the structure.

3. Annual Reporting and Compliance

Running a limited company involves significant administrative responsibilities and costs which includes:

• Filing annual accounts with Companies House
• Submitting corporation tax returns to HMRC
• Maintaining accurate records of income, expenses, and transactions
• Complying with Companies House regulations, such as filing confirmation statements and updating director details

These tasks can be time-consuming and often require professional assistance from an accountant or tax advisor, adding to the overall cost of running the company.

Failure to meet compliance deadlines can result in penalties and damage to the company’s reputation, making it essential to stay on top of reporting requirements.

4. Stamp Duty Land Tax (SDLT) on Transfers

If you already own a personal property and want to transfer it into a limited company, you may be liable for Stamp Duty Land Tax (SDLT). SDLT is calculated based on the property’s market value at the time of transfer, and rates can be as high as 15% for high-value residential properties.

For example, if you are transferring a property worth £50,000 into a limited company, it could result in an SDLT bill of £15,000 (assuming that the residential rates are standard). This upfront cost can be a significant barrier, particularly for landlords with multiple properties.

Read more on how to avoid SDLT legally

5. Limited Access to Personal Allowances and Reliefs

Limited companies do not benefit from personal allowances or certain tax reliefs available to individual landlords. For example:

• Personal Allowance: Individuals can earn up to £12,570 tax-free each year, but this allowance does not apply to limited companies.
• Property Income Allowance: Individual landlords can claim a £1,000 tax-free allowance for property income, but this is not available to companies.
• Capital Gains Tax Annual Exempt Amount: Individuals can benefit from a £6,000 annual exemption (2023/24) for CGT, but companies do not have access to this relief.

These limitations can reduce the overall tax efficiency of holding property in a limited company, particularly for landlords with smaller portfolios or lower rental incomes.

Balancing the Pros and Cons

While the tax benefits of buying property through a limited company can be substantial, it’s important to weigh these benefits against the potential drawbacks. 

Higher mortgage rates, additional taxes on profit extraction, and the administrative burden of running a company can offset some of the advantages, particularly for smaller-scale landlords.

Before making a decision, it’s crucial to:

• Assess your portfolio size and long-term goals
• Calculate the potential tax savings and costs
• Seek professional advice to ensure compliance and optimise your tax strategy

By carefully considering these factors, you can determine whether buying property through a limited company is the right choice for your investment strategy.

Key Considerations Before Setting Up a Limited Company

Before deciding to buy property through a limited company, it’s essential to evaluate your financial goals, portfolio size, and long-term plans. Here are the key factors to consider:

1. Portfolio Size and Profitability: Limited companies are often more tax-efficient for larger portfolios or higher rental incomes. Smaller landlords may find the costs outweigh the benefits.
2. Mortgage Costs: Limited company mortgages typically have higher interest rates and stricter criteria, which can impact the overall affordability of the property.
3. Tax Implications: While corporation tax rates are lower, extracting profits through dividends can lead to double taxation.
4. Administrative Burden: Running a company involves annual reporting, compliance, and accounting costs, which can be time-consuming and expensive.
5. Future Plans: Consider your goals, such as reinvesting profits, passing down assets, or scaling your portfolio.

Seeking professional advice from a tax advisor or accountant is crucial to ensure this structure aligns with your financial objectives and maximises tax efficiency.

Read more about How To Set Up A Limited Company

Practical Steps to Buy Property Through a Limited Company

Once you have set up a limited company using the guide mentioned above, the next step is to buy a property using this company. 

Here are some practical steps you can follow to buy a property through your limited company.

Practical Steps to Buy Property Through a Limited Company (200 words)

1. Set Up a Limited Company: Register your company with Companies House, choosing a unique name and appointing directors and shareholders. Ensure the company’s articles of association allow for property investment.
2. Open a Business Bank Account: Separate your personal and company finances by opening a dedicated business bank account. This is essential for compliance and accurate record-keeping.
3. Secure a Limited Company Mortgage: Research lenders offering mortgages to limited companies. Be prepared for higher interest rates and stricter criteria, such as larger deposits or higher rental coverage ratios.
4. Purchase the Property: Once financing is in place, complete the property purchase through your company. Ensure all legal and tax requirements, such as Stamp Duty Land Tax (SDLT), are addressed.
5. Maintain Accurate Records: Keep detailed records of income, expenses, and transactions to simplify annual reporting and compliance. Use accounting software or hire a professional to manage this.
6. Plan for Tax Liabilities: Work with an accountant to optimise your tax strategy, including corporation tax, dividend distributions, and reinvestment plans.
7. Stay Compliant: File annual accounts with Companies House and submit corporation tax returns to HMRC on time to avoid penalties.

By following these steps, you can effectively navigate the process of buying property through a limited company while maximising tax efficiency and compliance.

Case Study

Example 1: Small-Scale Landlord with 2 Properties — When Staying a Sole Trader Makes Sense

Scenario:

Sarah owns two rental properties with a combined annual rental income of £40,000. She has a mortgage on each property, with total interest payments of £12,000 per year. She is a basic-rate taxpayer and plans to keep her portfolio small.

Analysis:

• As a sole trader, Sarah’s taxable profit is £28,000 (£40,000 income – £12,000 mortgage interest). After deducting her personal allowance (£12,570), she pays 20% income tax on £15,430, resulting in a tax bill of £3,086.
• If Sarah set up a limited company, she would pay 19% corporation tax on the £28,000 profit, totaling £5,320. Additionally, extracting profits as dividends would incur further tax, reducing her overall savings.

Conclusion:

For small-scale landlords like Sarah, the costs of setting up and running a limited company (e.g., accounting fees, higher mortgage rates) may outweigh the tax benefits. Staying a sole trader is likely more cost-effective.

Is a Limited Company Right for You?

Buying property through a limited company has significant tax benefits, such as lower corporation tax rates, full mortgage interest deductibility, and inheritance tax planning advantages. 

However, it also comes with its fair share of challenges, including higher mortgage rates, additional taxes on profit extraction, and the administrative burden of running a company.

If you are a small-scale landlord, staying a sole trader may be more cost-effective. However, if you are a growing portfolio investor and are focused on legacy planning, you can benefit greatly from the tax efficiency and flexibility of a limited company structure.

Before making a decision, seek expert advice from a tax advisor or accountant to evaluate your specific circumstances.

Balancing tax efficiency with business flexibility is key to long-term success.