When looking to purchase an investment property, one of the first issues to consider is whether the property should be held privately or via a company.
Legally speaking, the company owns its assets rather than its shareholders or directors, since corporations are separate legal entities. The firm owns the rental revenues and profits from further sales, which are subject to corporation tax at the present rate of 19%. Salary and dividends are liable to income tax and national insurance at varied rates based on the amount of income earned by a person during a tax year.
“What is your aim with the profits?” is the most important question to ask.
A corporation wrapper may be preferable if the objective is to reinvest gains or build up cash reserves since profits that are not necessary to be retrieved are not subject to income tax. If the property is held in the name of a person, the gains are taxed at the time of receipt.
Individuals could previously deduct interest on buy-to-let mortgages as a business expenditure, lowering their taxable earnings. Individuals will only get relief in the form of a tax credit up to their basic rate band from April 6, 2020, after this assistance has been tapered down over the last three years.
However, if a person receives considerable rental revenues, they should consider forming a corporation. Significant earnings are over £100,000 per year since an individual’s allowance is capped at this amount, and gains are taxed at 40% or 50% above £150,000.
If a person receives a considerable rental income of above £100,000, they should consider forming a corporation. Over this profit threshold, the income tax rate rises to 40% or 45 per cent above £150,000, and the personal allowance is reduced.
Is it legal for a director to live on the business property?
As previously stated, profits that are reinvested rather than extracted are not subject to income tax or national insurance. A benefit is received when a firm acquires property for a director or shareholder to live in.
The legislation tries to penalise a corporation in different ways to dissuade shareholders and directors from using corporate reserves to acquire personal property and therefore avoid paying income tax to HMRC.
A benefit in kind might occur if a director, or a member of an employee’s or director’s family or household, is given living accommodations and the related advantages such as utilities, furnishings, and other services provided by the firm.
If the value of the property reaches £500,000, it is subject to a special Stamp Duty Land Tax (“SDLT”) and Annual Tax on Enveloped Dwellings (“ATED”) system.
Stamp duty
If a non-qualifying person inhabits the property during the first three years after completion, a 15% SDLT flat rate charge will be applied at the time of acquisition.
Anyone associated with the firm is a non-qualifying person. This includes board members, stockholders, and their associates. Their relatives, spouses or civil partners, spouses or civil partners’ family, and others, for example. Even if the rent is to be paid at market value, the fee is imposed.
Annual Enveloped Dwellings Tax
ATED, a yearly fee depending on the property’s value, is closely similar to the above. ATED, unlike SDLT, does not expire after three years; it is charged until a property is sold, and it may be quite expensive.
The ATED fee for 2021/22 is £7,500 if the home is worth £1 million. Unlike other taxes, ATED is due a year in advance to make matters even more complicated, and non-compliance carries severe penalties.
Does it make a difference if a home is leased or designed for resale?
Redeveloping a house for sale is a trade, but renting out a home is an investment. This difference is critical whether a property is owned individually or by a corporation since the activities are taxed differently.
Individuals who obtain rental revenues from residential properties are liable to income tax, with capital gains tax (CGT) payable at 18% or 28% when the property is sold.
Individual investment operations are liable to income tax, NIC, and capital gains tax (CGT) at 18% or 28% on sale.
When computing trading profits, the whole mortgage interest may be deducted, and the earnings are liable to income tax and NIC.
If a firm intends to invest, the property will be recorded as an investment property at market value in the financial accounts. Profits are subject to corporation tax, and a taxable gain is determined when a business is sold. Unlike the previous example, the gain is subject to corporation tax. However, some expenses will be deducted from yearly earnings, and certain capital expenditures will be deducted from the property’s cost until it is sold. This implies that certain expenses will not be tax-deductible until they are sold.
If a property is being constructed for resale, it will be recorded as stock in the financial accounts at cost. Corporation tax applies to profits and sale proceeds. As a consequence of its actions, a property developer may need to examine different regimes.
The works will be covered by the Construction Industry Scheme (“CIS”) if subcontractors are used to developing the property. CIS requires monthly returns and further compliance; please consult your accountant or tax consultant before beginning work.
If it is later determined that a property will be held as an investment rather than sold, a corporation might face a “dry” tax charge when transferring it from cost in stock to market value in investment property. A dry tax charge is one in which tax is payable, but no revenues are collected.
