Look into investing for rental income in the UK, and you’ll invariably be told to purchase your buy-to-let property through a limited company.
Old property codgers and young influencers are united: it’s a no-brainer.
Well, perhaps senility is setting in at Monevator Towers, but I don’t see the case for acquiring a buy-to-let property through a limited company as completely clear cut.
At least, not for me. And probably not for all of you.
I’m thinking here of people who’d invest in just one or two buy-to-lets (BTLs) to create an income to help fund their (early or other) retirement.
Sure, if you’re a budding property mogul (like every second YouTuber it seems) then build out your BTL empire through limited companies.
Similarly, if you’re a high-earner and hence a higher-rate tax payer and you expect to stay that way – maybe even into retirement – then yep, No Brains Required. A limited company is the best choice.
But everyday escapees from the 9-5?
The likes of my co-blogger, The Accumulator, who aims [1] to sustain him and his missus on an annual income in the £20-something thousands?
In that case there are pros and cons.
Owning a BTL in your name might actually be a better route, as we’ll see.
Why own rental property?
First a quick summary of why you’d invest in a buy-to-let for income.
Here at Monevator, we focus on the liquid, low-hassle advantages of shares, bonds, and their various fund incarnations.
However it’d be silly not to see how valuable a rental property can be.
Indeed in most corners of the UK and in the media – where property appears to be ‘my pension’ under some ancient Trade Descriptions Act – the argument hardly needs to be made.
For millennia, give or take the odd rough patch, the rich stayed rich by owning property (and land) and charging the common oiks for using it.
A skim through The Sunday Times Rich List shows little has changed.
It’s not easy to get wealthy via real estate, starting from scratch.
But as a way of preserving wealth got some other way, it’s tough to beat.
In the UK, property prices have mostly been rising since World War 2, even after adjusting for inflation:
[2]Source: Economics Help [3]
Lots of people are angry about this, of course. But that’s for another day.
The point is while it’s subject to fluctuations like all risk assets, residential property has – over time – preserved (and grown) spending power.
Better yet, let out your property to tenants [4], and you can expect the income you receive to rise, too:
[5]Source: Office for National Statistics [6]
True, rents have softened [7] recently in some cities, thanks to the Covid pandemic. But short-term fluctuations aren’t the point with property.
Real estate is a long-term asset. Prices and rents have risen faster than inflation [8] for generations.
Buy a decent property with fair rental potential, and you can reasonably expect to enjoy a rising income throughout your retirement years.
It’s not all kerching!
Before the peanut gallery gets going, let’s agree there are other factors to consider with rental property.
Tenants can be a hassle. Houses can fall down. And do you really want to be refitting a two-bedroom flat on the sixth floor in your seventies?
But this article isn’t about all the issues with buy-to-let. I’m just pointing out that rental properties have appealing characteristics. Bought right, they can play a role in a diversified retirement income strategy.
Personally, I’d always consider a mix [9] of different assets. Rather than devolving down to the usual Internet stance of A Is Good but B Is Evil.
There are many ways to skin a cat, as they say (although I can only think of one ghastly method. Pretty horrid, even if you’re not the cat.)
With an open mind, let’s crack on!
The BTL boom
Buy-to-let used to be so easy, as Simon Lambert noted [10] back in 2015:
… £1,000 invested into buy-to-let in 1996 would be worth £14,900 at the end of 2014.
It comfortably beat all other assets. The same £1,000 invested in shares would be worth £3,119, while a cash pot grew to £1,959.
ThisIsMoney, 16 April 2015
In the 1990s, City boys with bonuses and 50-somethings paranoid after pension scandals found they could deploy newly-competitive BTL mortgages to outbid first-time buyers for the proverbial two-bedroom flat.
Finance the purchase with an interest-only [11] mortgage, rent it back to the poor sods you priced-out, and boom [12]!
Literally. UK house prices soared.
Lots of new landlords got legions of renters to finance growing portfolios of buy-to-lets. If you weren’t worried about a price crash (alas I was [13]) then the economics of leveraging up even as rental yields fell were compelling.
It all got a bit embarrassing for politicians. Governments like high house prices, but the affordability argument [14] was becoming impossible to ignore.
Conservative politicians were torn between promoting home ownership and the perception that it was becoming concentrated in fewer hands.
That didn’t matter at first – landlords being more a Tory’s natural constituency than public sector renters, say – but the numbers [15] got silly.
Why limited companies are even a thing with buy-to-let property
Thus it was oddly enough a Tory government that began to turn the tide.
Various bungs to help first-time buyers [16] get into the market and compete with landlords were extended. (Whether sensibly or not.)
And a more hostile environment [17] for landlords came into being.
Within just a few years an additional stamp duty rate for the purchase of second homes was introduced. Capital gains tax breaks on BTLs you’d previously lived in were harder to qualify for. And – slowly, but most significantly – the economics of using a mortgage to finance a buy-to-let were squeezed. Hard!
In Ye Good Old Days, a landlord set all of their mortgage interest payments on a BTL against the rental income. They only paid tax on what was left.
But since April 2020, landlords cannot set any interest expenses against rent. Instead there’s a tax credit worth 20% of the interest payments.
This is bad for higher-rate taxpaying landlords using mortgages. It means much higher tax bills and a lower net income.
The tax maths as a higher-rate tax-paying BTL owner
Let’s suppose that higher-rate taxpayer Bob gets £1,000 a month rent on his BTL and his mortgage interest expenses are £700.
Prior to the new rules, Bob could have set his annual interest-only mortgage cost of £8,400 against his £12,000 of rental income.
That left £3,600 in profit, of which £1,440 went to tax (levied at 40%) and £2,160 ended up in Bob’s pocket.
Today, however, Bob is liable for tax on the £12,000 of rental income at his highest rate of 40% – so £4,800. He is only able to reduce this with the 20% tax relief on the £8,400 interest payments, which equates to a £1,680 credit.1 [18] This means £3,120 goes to HMRC.2 [19]
Bob still has his mortgage interest to pay, so his total costs are £8,400 plus £3,120 in taxes. Deducting both from the £12,000 income leaves just £480 in Bob’s bank account. (And that’s ignoring all Bob’s other expenses).
A dramatic collapse in net income from £2,160 to just £480.
Note that if Bob was a basic-rate taxpayer, nothing has changed. Under the old system he’d have paid £720 in tax.3 [20] Under the new system, basic-rate Bob has a £2,400 tax liability, but gets the same £1,680 tax credit. Hey presto: £2,400-£1,680 = £720 tax to pay, as before. Bob’s net income would be £2,880.
Tax under limited company ownership
When a limited company owns rental property, it’s treated like any business with income and expenses. This means the entire mortgage interest cost can be set against the rental income (again, along with various other expenses, which I’m ignoring for simplicity).
Corporation tax is paid on the resultant profit.
This makes a rental property owned by a limited company a much more lean, mean profit machine.
For example, let’s assume for now all the numbers stay the same. (In practice expenses would likely be higher with a limited company).
Income of £12,000 minus £8,400 in interest payments leaves £3,600 profit. At a corporation tax rate of 19%, that sends £684 to HMRC, leaving £2,916 in net profits.
On the face of it a stellar slam dunk for limited company ownership! But keep reading. (Spoiler: It’s more complicated.)
Other pros and cons of purchasing a buy-to-let property through a Limited Company
These tax changes are why BTL landlords have rushed to set-up limited companies (or SPVs4 [21] as they like to call them. It’s just a sexier name for a limited company with a relevant tax code).
But there are other advantages – and disadvantages – to owning and letting out property this way.
Advantages of owning BTLs in a limited company include:
- Profit being taxed at lower corporation tax rates, as above.
- Some mortgage providers may be satisfied with less onerous stress tests on a property’s ability to cover the mortgage (but should you be?)
- In theory you have limited liability, since it’s the company not you that owns the property. However you’ll probably have to give personal guarantees to get a mortgage, and directors can be sued, too. Also many landlords take out comprehensive insurance [22] against mishaps, anyway.
There are also disadvantages to going down the limited company route:
- Limited company mortgage interest rates have fallen, but rates are still higher than the best personal BTL rates.
- You’ll probably need to use an accountant, and do more paperwork.
- That will add extra expenses to running your rental property.
It’s worth noting too that a limited company still has to pay the extra 3% stamp duty payable on additional homes. So you’re not dodging that.
And corporation tax is rising [23], as per the March 2021 Budget. The limited company advantage might theoretically be trimmed.
The new 25% rate will only begin to be phased in for businesses with profits over £50,000, though – which will exclude the vast majority of ordinary landlord’s portfolios. (For the time being, anyway).
End of story? Not for basic-rate taxpayers
By now you might think owning a BTL through a limited company has an unassailable edge, even for the humblest landlords in retirement.
Income is the point, right? And on the face of it, limited companies clearly chuck out more cash.
However in some circumstances that might not be the case.
Remember my note above that the tax changes didn’t alter the economics for basic-rate tax payers?
Well that might be a throwaway side-note for high-earners looking to build out chunky rental portfolios.
But for basic-rate taxpayers – such as a great many retirees, especially FIRE5 [24] devotees who pull the plug early – it’s a very big deal.
My sums above showed limited companies deliver higher cashflow at the per-property level.
But you must extract the money from the limited company to spend it!
And it’s here the picture gets more nuanced for basic-rate payers.
You might get a higher income than if you own your BTL through a limited company
This is not something those empire-building property gurus focus on. Good luck to them, but know that using a limited company for one or two properties might actually result a lower income for you.
The issue is that corporation tax isn’t the end of the story.
When you come to remove money from your company – as you would if you were living off the rental income – you’d normally do it as a dividend.
Depending on your other sources of income, there could be dividend tax levied at:
- A basic-rate of 7.5%
- A higher-rate of 32.5%
- Or even 38.1% if you’re a retired oligarch paying the additional rate
You do get a tax-free dividend allowance of £2,000, which helps.
But remember dividends from other sources (such as shares held outside of shelters) count towards that £2,000 allowance.
We saw that as a private landlord, basic-rate taxpayer Bob paid only £720 in tax and got an income of £2,880 from his BTL.
If Bob had acquired his BTL inside a limited company, we’ve also already seen the company would have been left with £2,916, after corporate tax.
Now let’s say Bob extracts this as a dividend, and is able to use his full dividend allowance. In his case £916 is liable for tax at 7.5%, which means £68.70 goes to HMRC and Bob is left with £2,847.
That’s slightly less than he got as a private landlord.
Worse, if Bob had already used up his dividend allowance elsewhere, his net income falls to £2,697.
The net income from the limited company would probably be even lower still in practice. Bob would have accountancy bills to pay of £1,000 or so a year, albeit these are also expenses that will reduce corporation tax.
All told, it’s not hard to see the annual income after expenses and taxes from the limited company falling towards the £2,000 mark.
Other complicating factors
I could give other examples that made things look better or worse.
The important thing is to apply the numbers to your own situation.
When you do so, there are other issues you need to consider.
Most importantly, rental income might push you into a higher tax band.
This is especially important if you’re not using a limited company, since the full rental income is going to be added to your income from other sources.
With a limited company, you might want to make payments into your own pension, which is a more tax-efficient way of getting the money out.
Indeed, in either scenario, an early retiree will likely have various income levers to pull.
For example you might reduce the drawdown from your SIPP to keep your pension income plus rental income below key tax thresholds.
There’s also the usual opportunities for shenanigans for couples involving who owns what.
But this post is already insanely long, and I can’t cover every scenario.
The point is to think carefully about what you hope to get out of any rental property, and where you are in life.
Then run the numbers for yourself.
Two’s not a company, but three or four…
With all this written, I would probably invest in buy-to-lets through a limited company if I ever go down this path.
That’s because if you don’t intend drawing the income for a long time, it’s definitely more tax-efficient to keep the profits inside the company.
Retaining more profit means more money to put into your next purchase.
Also, the more rental properties you own, the more you spread the limited company hassle factor – and your accountancy fees, too.
And if you want to invest with other people, you’d best do it through a limited company (or possibly a limited liability partnership, but please do your own research on that). It’ll be the proper way to structure it, legally.
Finally there may be estate planning advantages with limited companies. Consult your professional advisors if that’s a factor for you.
Know your limits
I suspect the government wants to see the whole rental sector inside limited companies. That way it can better monitor – and regulate – what’s going on.
So maybe things will get even harder for landlords operating outside them.
What’s more, even if you only intend to own one or two rental units, you might unexpectedly become a higher-rate taxpayer further down the line.
Moving existing BTL properties into a limited company will be an expensive pain. So you may decide it’s better to start that way.
Fair enough.
But if you are on the cusp of retirement and you just want to buy and let out a flat or two to add £500 a month to a fairly modest retirement income, I’m not sure it’s worth the bother.
Do your own sums though, and figure out what works best for you.
Many [25] readers [26] have lots more experience with property than me, and I’d be interested in your insights. Remember my modest use case: I agree you should always acquire a larger portfolio of buy-to-lets through a Limited Company, or if you’re a higher-rate payer. Also let’s please minimize the landlord name calling and predictions of property Armageddon, for the sake of a good discussion. Thanks!