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  • Writer's pictureInvestment Synergy Team

Buy-to-let: Why more landlords are setting up companies

February 2023, The Times

Buy-to-let owners are finding ways around government measures that make it harder for them to turn a profit...

More landlords are setting up companies to try to boost their profits.

By the end of last year there were 309,643 buy-to-let companies in the UK, according to the estate agency Hamptons, up from 228,743 at the end of 2020.

The buy-to-let mortgage broker Mortgages for Business (MfB) said that 65 per cent of the loan applications it received in January were from limited company landlords, compared with 40 per cent in January 2016.

Paul Fryers from the specialist buy-to-let lender Zephyr Homeloan said: “Changes to tax relief has led to increasing numbers of property investors setting up limited companies to buy one or more rental properties. Limited company lending now comprises most of our business.

“We are also seeing increasing numbers of savvy parents setting up limited companies to buy properties for their children — a rarity even up to five years ago. The landscape has shifted from simply providing finance as the Bank of Mum and Dad to parents taking on formal company responsibilities to help their children on to the ladder.”

New tax rules meant that from April 2020 landlords could no longer deduct mortgage interest payments from their rental income before declaring it for tax purposes. Instead they get a tax credit equivalent to 20 per cent of their mortgage interest, which is half what a higher rate taxpayer would have been able to claim previously.

This change, coupled with a stamp duty surcharge on the purchase of additional homes and tighter regulations around the energy efficiency of properties, prompted many landlords to quit the market. This means demand for rental properties is outstripping supply, the Bank of England said this week.

Landlords or second-home owners sold off a record 47,000 properties in the three months to the end of November 2022, according to the estate agency Savills. This was up 21 per cent on the year before.

Other landlords, however, opted to hold properties through a limited company so that they can still deduct mortgage interest from their rental income before paying tax on it. There are extra benefits for higher rate taxpayers too. Here’s what you need to know.

The pros

Holding property in a company structure has also become more attractive as interest rates have increased. The average rate on a five-year fixed buy-to-let mortgage at 75 per cent loan-to-value was 6.24 per cent in January, according to MfB, up from 3.23 per cent a year ago. This would add £502 to the monthly payments on a £200,000 interest-only mortgage.

Gavin Richardson from MfB, said: “Rising interest rates have been the last straw in convincing people into limited company structures.”

To qualify for a buy-to-let mortgage you must pass a financial stress test with a lender. Individual landlords who are higher rate taxpayers must prove that their rental income can cover 145 per cent of their mortgage payments, whereas limited companies (and basic rate taxpayers) only need to prove that they can cover 125 per cent.

The Mortgage Works, the buy-to-let arm of Nationwide Building Society, stress tests a higher rate taxpayer at a mortgage rate of 6.19 per cent if they want to fix for five years, compared with a rate of 5.79 per cent for limited company landlords.

On a 75 per cent mortgage for a £400,000 property, the limited company landlord would need about £22,000 a year in rent, but a higher rate taxpaying individual landlord would need to earn about £27,200.

“Mortgage firms will typically lend larger amounts based on rental income for limited companies versus personal owners,” Newton said.

Individual landlords pay tax on rental profits at their usual rate of income tax, while rental income earned through a company is subject to corporation tax at 19 per cent (rising to 25 per cent in April). Company directors that take pay in dividends can also earn £2,000 a year free of tax — £1,000 from April and £500 from April 2024. Above this, dividends are taxed at 8.75 per cent for basic rate taxpayers and 33.75 per cent for higher rate taxpayers.

The cons

Before you rush to set up a property company, there are some downsides to consider. Mortgage rates, for example, have historically been higher (although this gap is closing). In January the average limited company mortgage was 6.56 per cent, compared with 6.24 per cent for a standard buy-to-let mortgage — an extra £53 a month on a £200,000 interest-only mortgage.

Jed Newton, a director at the mortgage broker Trinity Financial, said that arrangement fees are another downside. Newton said: “Some lenders have tried to innovate by offering large fees with lower interest rates. In most cases it does not make financial sense to pay fees of 7 per cent to secure a rate when these fees are usually 2 to 3 per cent.”

There are tax issues in incorporating too. Moving a property from private to company ownership is treated as a property sale, meaning that you incur stamp duty — including the 3 percentage point surcharge. You will also pay capital gains tax if the property has increased in value by more than your £12,300 annual CGT allowance. There may also be mortgage and valuation fees to pay.

Some landlords may be better off keeping existing property in their own name, but buying any additional ones using a limited company.

Kevin Dunn from the advice firm Furnley House said: “Accidental landlords who are not building an empire and are basic-rate tax payers, may have no need to set up a property company. But for those who already have a portfolio or are higher-rate tax payers there most definitely is a point.”

Paul Falvey from the accountancy firm BD, said: “Running buy-to-lets through a company structure can be a good option, but it brings additional administrative burdens. It is over-simplifying matters to say that incorporation is the most tax-efficient option.”

‘I save £60 each month as a company’

Matt Robson, 38, a former pilot, holds 12 properties in the north east of England in his own name and six, soon to be eight, through a company.

As well as his rental properties, he runs the firm Blue Skies Property Investment, which he set up in 2020 after being made redundant from the airline. His buy-to-let properties are worth about £100,000 each and mortgage payments are about £350 a month each. Robson estimates that he is £60 a month better off from holding property through a company, even if his mortgage rates are higher, because he can offset the interest.

Robson said: “After the phasing out of interest relief, I looked at my tax situation and realised I’d be better incorporating.”

Investment Synergy - the buy to let investment proposition is becoming more financially challenging for the smaller investor, not to mention the considerable ethical impact on passing on increasing costs to beleaguered renters....

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