Landlords urged to do the maths before considering incorporation

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Times are changing for the UK’s residential landlords. From this month, there will be changes to the wear and tear allowance, and from April 2017 there will be restrictions on the amount of mortgage relief available.

The mortgage relief restrictions will only affect those who own the investment property personally. Top rate tax payers will see the amount of tax relief they can deduct fall from 45% to 20% but companies which invest in residential property pay a fixed rate of tax on their profit. Many accountants and property professionals are urging landlords to incorporate to save money on their tax bill. Benham & Reeves Residential Lettings takes a more cautious approach and says it can depend on landlords’ circumstances.

For existing landlords, it may not make financial sense to incorporate their existing portfolio. In effect, these landlords would have to “sell” their portfolio to their new company, thereby incurring stamp duty land taxes (SDLT) in doing so. The savings made on mortgage relief are unlikely to be enough to mitigate the 5-12% SDLT for quite some time. There are certain circumstances in which the SDLT would not be payable but for most landlords the tax would be compulsory. There is also a possibility of triggering a capital gains tax (CGT) if incorporation relief cannot be claimed.

The bigger question is whether new property investors or existing landlords seeking to add to their portfolio should do so through a company. Benham & Reeves Residential Lettings has run a series of calculations and determined that for most investors – even high rate tax payers – it still pays to buy the property in one’s own name rather than through a company. This surprising conclusion takes the extraction of profits from a sale into consideration.

Although the monthly rental profit may be higher for the company as it does not pay the higher rates of tax, ultimately the private landlord comes out ahead financially once dividends or CGT on liquidation following the sale of the property are taken into account. To realise the company’s assets, the company either has to issue a dividend or will have to be liquidated which will trigger CGT on the distribution that has already been subject to corporation tax. What’s more, mortgages are more difficult for companies to obtain and are subject to commercial rates, thereby eroding the mortgage relief gains.

Vidhur Mehra, finance director at Benham & Reeves Residential Lettings, comments: “Although some professional advisors are advocating incorporation, we have run the figures and in many circumstances, private landlords come out ahead financially. That said, each investor is different, each portfolio is different and there are different timescales for investment with some looking at the medium term and others seeking to hold onto their portfolio indefinitely. While there has been a lot of noise in the press with financial advisors urging incorporation, we are saying that it might not suit all. There are a lot of hidden costs inherent with incorporation and these costs need to be taken into account before taking such a drastic step.”