Many of you will own or plan to own, one or more investment properties as part of your overall wealth portfolio, providing you with both current rental income and a future capital asset. But should these properties be owned in your personal name, or via a company that you own?
The decision as to which structure to use should be made with reference to both taxation and commercial issues. There are principally five different structures to consider; personal ownership, Limited Liability Partnership (LLP), an investment company, trading company or a pension scheme. In addition to the commercial aspects, there are generally four main types of tax to consider with each structure; taxation of rental income (whether income tax or corporation tax), capital gains tax (CGT), inheritance tax (IHT) and stamp duty land tax (SDLT).
Sole-traders, partnerships and LLP’s fall under the same rules. Property owned this way is attractive from a CGT perspective as sales can be made with both the advantage of comparatively low rates of CGT at 18% or 28%, and after the deduction of annual capital gains tax allowances for each partner, and possibly even their spouse if they were introduced as partners to the business (currently £11,000 per person). The downside is that the taxation of rent will be at the individual’s highest rates of tax currently being paid (i.e. up to 45%). It can be seen therefore that this structure suits a strategy of short-term property ownership with a view to making a capital gain, or individuals taxed at the basic rate operating a very small portfolio.
Properties held in this manner form part of an individual’s estate for IHT purposes. Where an estate exceeds the nil rate band of £325,000 the excess is subject to IHT at 40%, unless the estate is being transferred to a surviving spouse, in which case no IHT is payable on the estate until the death of the surviving spouse.
Where the strategy of the business is the long term retention of properties, with any profits being used to buy further properties, the primary goal will therefore be attaining the lowest income tax rates to leave more cash in the business for those further acquisitions. A limited company structure would therefore be preferable with 80% of profits being retained (the current rate of corporation tax being just 20%). A small niche market exists for the sale of companies with larger property portfolios, thus facilitating a whole-company sale in the future, rather than sales of individual properties from within it. Such a share disposal would also incur reduced SDLT for the purchaser (1/2% for company shares versus as high as 7% for individual property purchases) and avoid the double taxation trap…. read on!
The downside to portfolio ownership by an investment company is when the individual properties are disposed of. Firstly the company would suffer corporation tax at 20% on the initial sale. The shareholders would then extract the remaining proceeds via a dividend, incurring up to 36.1% in income tax for very high earners. The overall tax rate would therefore be circa 50%.
The increased rate of tax on ultimate property sales of up to 28% via personal ownership noted above, to as high as a combined rate of 50% via a company, must be set against the number of years of ownership during which the company will save the difference between the rates in personal income tax of up to 45% and corporation tax of only 20% on property rental income.
Shares in a limited company form part of an individual’s estate for IHT purposes in the same way that the properties would do if they were held individually or through a partnership.
Shareholders operating in a trade or profession may use the trading profits to purchase a property within their existing trading company rather than setting up a separate property business, thus avoiding the income tax on extracting trading profits to make a purchase. Upon retirement the trade may be sold separately to the property, suffering only corporation tax rates (20%) on the gain. The property is then left in the company, which is now deemed as an investment company as above. The shareholders are now in a position to draw down a retirement income from the business in the form of tax free basic rate dividends at up to (currently) circa £36,000 per annum.
A formal pension fund is a particularly tax efficient way to own the property. However, they are sadly restricted to owning only commercial properties, and cannot invest in residential property.
The decision as to whether to own your properties in one of the personal formats or company formats depends on the strategy you have for your property portfolio. If you own perhaps only one or two properties as a current investment, that you intend to dispose of in the short to medium term, it is more beneficial to suffer the higher rates of income tax on the rental income, and enjoy the lower rates of capital gains tax when you sell. Where however, you have a strategy of building a larger portfolio of properties over the longer term, and possibly an asset to pass onto future generations, the key is cash retention of rental income. Under these circumstances, property investment is most suited to a limited company.
Where further doubt remains as to strategy, in particular the length of planned ownership, a detailed calculation on the whole portfolio would be advisable. This exercise should be carried out by a suitably qualified tax adviser, who would also be able to advise you upon the multitude of other tax implications relating to property ownership.