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Buy-to-let properties – the pros and cons of setting up a company.

Several key tax changes have hit buy-to-let investors’ profits.

The additional stamp duty surcharge of 3pc has made buying a property to rent more expensive at the purchasing stage, often to the tune of tens of thousands of pounds. And changes to tax relief, due to be fully phased in by 2020, are forcing many mortgaged landlords to adjust their expectations of returns.

The stamp duty changes were introduced by former chancellor George Osborne last year and mean anyone purchasing an additional house above the value of £40,000, must pay 3pc on top of the stamp duty already levied.

The phasing in of tax relief cuts, meanwhile, began in April. Before then, landlords could offset interest paid on a mortgage from their profits before tax calculations. Now tax relief is only available on 75pc of the interest, and by 2020 it will not be available at all, and will instead be replaced by a tax credit. The effect will be that all mortgaged, higher-rate taxpayers will lose income.

Other landlords might see the changes push them into a higher tax bracket, even though they are not actually experiencing an increased income.

The changes have prompted a cooling of the buy-to-let market, as nervous investors shy away from buying new property.

But, as has been well-publicised, those landlords purchasing through a limited company structure are exempt from these changes. So, at what point would it make financial sense not to own the properties directly, but to set up as a company and own the properties through that instead? Here, mortgage broker Private Finance has crunched some of the numbers.

The financial pros and cons of setting up a company
Director Shaun Church 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 clear route to saving money.

One of the downsides, he points out, is the higher cost of borrowing via a company structure (see below).

“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.”

What are the costs of running a limited company?
It costs little to actually register a limited company with the Government. Using an intermediary can be easier as they will deal with all the relevant forms, but will set you back around £100 – whereas doing it yourself costs only £12.

Limited companies are obliged to file annual tax returns. As well as a small charge for actually submitting your returns, it may be necessary to hire an accountant to help.

The main expenses however, can be seen when it comes to borrowing. Limited companies can expect to pay hundreds more in terms of mortgage payments than individual borrowers.

According to Private Finance, a landlord with one property earning the UK average rental income of £11,010 a year on top of a base salary of £35,000 would take home close to £1,400 less each year using a limited company structure.

This landlord would pay a mortgage rate of 3.41pc when borrowing through a company, as opposed to 1.92pc as an individual. Based on a mortgage of 75pc of the property’s purchase price, Private Finance estimates the take-home income would be £1,369 less if owned via a business set-up.

So when does having a limited company structure pay off?
Clearly, higher interest rates mean small-scale property investors remain better off operating on a direct or individual basis – but there is a point when it will be cheaper to run as a company.

According to Private Finance that tipping point is four buy-to-let properties. A landlord renting out that number of properties at the UK average will then make £274 more than an individual counterpart.

This is based on rental income and base salary being £79,040. The annual mortgage costs will then by £19,646 for a company and £11,062 for an individual, but the tax bill will only be £9,435 rather than £18,604.

This makes the company’s net income £49,644, as opposed to the individual’s £49,374.

What if I already have an individually-held property empire?
Unfortunately, whether you only own one buy-to-let property or have a large portfolio as an individual, selling the properties and then “repurchasing” them within a limited company is unlikely to work out for you.

To transfer the properties from your own name to a company you will have to sell them, incurring potential capital gains tax. Stamp duty is likely to be payable when you re-purchase inside a business. This makes this method unfeasible for someone with a small number of properties.

Research by Private Finance suggests even those with a large number of buy-to-lets will be better off staying put. An investor with five rentals earning a £90,050 a year in income would have a take-home pay of £53,768 when acting as an individual.

Ordinarily, operating as a company, they would have a take-home pay of £54,584. But once stamp duty and CGT incurred by the transfer are taken into account this would plummet to 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.