Buy-to-let investors could see their income cut by £1,000 each year by purchasing through a limited company, according to Private Finance.
It says a limited company borrower can expect to pay 3.41% for a two year fixed 75% LTV mortgage deal, compared to 1.92% for personal borrowers.
Landlords investing through a limited company are excluded from recent tax changes that mean the amount of finance costs higher rate taxpayers can deduct from their rental income before calculating their tax bill is being gradually phased out. The restriction will be complete from April 2020. But for most landlords, the high cost of limited company mortgage borrowing will outweigh any tax advantages.
Private Finance says its findings suggest only landlords with multiple properties benefit from a limited company structure, with four properties being the tipping point in the firm’s research. Landlords looking to repurchase existing homes into a limited company are also likely to lose out as this move triggers costly capital gains and stamp duty taxes.
The analysis suggests it is more cost effective for new landlords purchasing one investment property to do so as an individual rather than through a limited company.
A landlord earning £46,010 annually (£35,000 base salary plus £11,010 in rental income – the average for a two bedroom house in the UK) will have £36,194 in take home income if purchasing as an individual (after tax and mortgage costs have been deducted).
If the same landlord purchased through a limited company, they would earn £34,825 in take home income: £1,369 or 4% less.
The main reason is that limited company borrowers pay higher rates on mortgage borrowing, with this putting a significant dent in net income.
Due to the higher cost of mortgage borrowing, the benefits of purchasing investment properties through a limited company are felt only when multiple buy-to-let homes are bought, Private Finance said.
Limited company landlords can subtract mortgage interest costs from their rental income before calculating their corporation tax. Even when paying income tax on a regular salary in addition to corporation tax, limited company borrowers will have a significantly reduced tax bill.
Having less to pay in tax eventually outweighs higher mortgage costs, but in the example used by Private Finance, this is only achieved once four or more properties are purchased.
For landlords who already have a number of buy-to-let properties, one option is to repurchase into a limited company structure. However, this incurs two major tax bills: capital gains and stamp duty, making it an inadvisable move for landlords with a small number of properties who do not have much to gain from being in a limited company.
However, Private Finance’s calculations suggest even larger landlords could be better off remaining as personal investors. A landlord with five rental properties, earning £90,050 in total income (a £35,000 salary and £55,050 in rental income) would have £53,768 in take home pay once mortgage and tax costs are deducted when acting as an individual.
If the same landlord was to repurchase their homes under a limited company, they would have £54,584 in take home pay. However, once capital gains and stamp duty costs are taken into account they would be left with just £5,374. Spreading these one-off payments across ten years, take home pay would be £49,663: more than £4,000 less per year than operating as an individual.
Shaun Church, director of Private Finance, said: “The option to invest through a limited company has come under the spotlight recently as landlords look for ways to offset recent tax changes. But landlords shouldn’t rush into this assuming it’s a safe bet for saving money. Limited company mortgage products are available through a handful of smaller lenders, resulting in higher rates compared to personal borrowing. Investors need to drive down mortgage costs as much as possible to prevent this from eating into their profits.
“Larger landlords might find the tax benefits associated with limited company ownership outweigh the higher cost of mortgage borrowing. Each investor is different and there’s no one-size-fits-all solution. Landlords should ensure they seek professional advice on how best to maximise their profits: an independent mortgage broker can help explain the range of options available to limited company and personal buy-to-let borrowers.”