More landlords are incorporating – will it benefit you?

Buy-to-let landlords are incorporating at a rate not seen for a decade. 

According to a recent report in The Daily Telegraph, landlords are setting up buy-to-let companies at a 10-year high. Incorporation is now becoming the default route for many new property investors.

So, incorporation is no fad. It is a rational choice, a response to structural tax changes that have taken place in the private rented sector over the last decade.

Following the originally phased (over 4 years) introduction of mortgage interest relief restrictions under The Finance Act 2015 – commonly referred to as Section 24 – the economics of personal rental property ownership have fundamentally shifted.

Section 24 replaced the full deduction of mortgage interest from rental income with a flat 20 per cent basic rate tax credit for individual landlords. Phased in between 2017 and 2020, this change means landlords are taxed on turnover rather than profit, significantly increasing tax bills for higher-rate taxpayers.

Higher and additional rate taxpayers are particularly hard hit but all landlords with property held privately have suffered a combination of increased taxes, higher mortgage rates and increasing costs with tighter margins. It’s hardly surprising that buy-to-let landlords are reassessing their position and considering placing properties in a corporate structure, with the tax advantages this can bring.

However, incorporation is not for everyone, it’s not a universal solution. For some investors it works. For others it introduces more complexity, cost and tax leakage. Before doing anything consult a specialist professional. 

A structural shift 

Before April 2017, individual landlords would deduct 100% of mortgage interest payments (as an allowable cost) from rental income before calculating tax due. Post April 2020 all that ended.

Today, private landlords receive only a 20% basic rate tax credit against financing costs. Higher and additional rate taxpayers can, ironically, find themselves in the invidious position of potentially paying tax on “profits” that they don’t receive in cash terms.

The tax credit system has the effect of increasing taxable income which means other landlords may be pushed into higher tax brackets, as taxable income is now higher than actual profit.

On the other hand, a limited company owning the same properties could still deduct mortgage interest in full as a business expense, before corporation tax is calculated, so it does not suffer the same restrictions. This is the main difference that has driven much of the incorporation trend.

What does incorporation mean in practice?

When you buy property through a limited company, the company owns the asset. It is a separate legal entity to the private individual who is then a shareholder in the company and a director. As a landlord you control the company, following the rules set down in the Companies Act, but you no longer personally own the property.

So, the company bills the tenant/s and receives the rental income; it pays running costs, files its own accounts and pays corporation tax on profits. The profits can then be retained in the company or distributed to directors (as dividends) as the director or directors decide.

Importantly, when individual directors take dividend payments or salaries these are then subject to income tax at their usual rate. 

This separation in ownership and control is central to understanding the tax and legal consequences of incorporation.

Note: This article applies primarily to England and is not a full interpretation of the law, Company and HMRC rules. Always seek professional advice before making or not making decisions. Use this guide as the starting point for your research, not an endpoint.

What is involved in setting up a limited company?

Setting up a limited company in the UK is relatively straightforward and virtually anyone can do it in a few minutes online at the Companies House website. Set up a limited company https://www.gov.uk/set-up-limited-company 

This involves registering with Companies House, appointing at least one director, and defining shareholdings. The company must have a unique name and prepare a "memorandum" (an agreement to form the company) and "articles” of association (rules for running the company) which are usually standard form and generated automatically. These will suffice for the average company.

The company is registered with Companies House by filing the company details (name, registered office address), directors’ and shareholders’ details along with “persons of significant control”.  The online registration fee is currently £50.

The registration also includes selecting the appropriate SIC Code, a Standard Industrial Classification (SIC) code (typically 68209 – letting and operating of own real estate) which best describes the business activity. 

As a separate legal entity, the business requires its own bank account to separate all business activities from the personal accounts of directors and shareholders. The company must also be registered for tax, with HMRC for Corporation Tax within 3 months of starting business activities. The company will receive its UTR (Unique Taxpayer Reference) and Corporation tax filing obligations.

The process can be completed within 24 hours usually. You will receive a Certificate of incorporation and a unique Company number. The company legally exists as a trading entity from that date. 

Unless the company is for a simple, small and straightforward business the process is best carried out with advice and the involvement of a solicitor or accountant. Setting up the company is usually the easy part; the complexity comes later in compliance and tax planning.

Accounting 

At a minimum the company needs a professional accounting system with bookkeeping software such as Sage, Xero, QuickBooks etc. Dividend documentation templates, board minutes templates and a payroll scheme (salaries are taken).

Every year, the company must file statutory accounts with Companies House and a corporation tax return (CT600) with HMRC. It will pay corporation tax (normally 9 months after year-end) and file a confirmation statement. It must operate PAYE if paying salary. Late filing penalties are automatic and can escalate quite quickly.

Accountant’s initial costs

Most landlords will need an accountant to deal with the complexities involved post the registration stage or even for the registration stage. Typical costs include: £50 basic incorporation (DIY) or formation by an accountant at £150-£400. Tax advice could be anything from £500 to £2,000.  If professional advice is needed on share structure, family ownership, alphabet shares, or future exit planning, initial costs increase further.

Annual company running costs

For a simple property company, say with 1–5 properties, typical costs will include: annual accountant’s charges at £750–£1,500, payroll (if directors take salary) £150-£300, bookkeeping if bookkeeper employed £400-£1,200 The annual confirmation statement fee is £50. So, a realistic cost for running a company would be in the region of £1,000 to £2,000. For larger portfolios or more complex structures (holding companies, multiple Special Purpose Vehicles), costs rise can rise considerably.

As of 1 April 2023, the UK’s main rate of Corporation Tax is 25 per cent on profits over £250,000, while a small profits rate of 19 per cent applies to businesses with profits of £50,000 or less. Companies with profits between £50,000 and £250,000 pay the main rate reduced by marginal relief, providing a gradual increase.

The headline corporation tax rate of 19 per cent or 25 per cent might look very attractive compared to 40 per cent or 45 per cent personal tax. But scale and extraction matters. Once directors pay dividend tax on distribution, the combined effective rate can approach or even exceed higher rate income tax.

Shareholders pay income tax on dividends exceeding a £500 allowance. Rates are 8.75 per cent (basic rate taxpayers), 33.75 per cent (higher), and 39.35 per cent (additional) currently.

If landlords don’t need the cash personally, they may decide to retain profits within the company to reinvest and grow the portfolio, and for larger portfolios a company structure is often materially more efficient. 

For directors needing to extract most or all the profits annually for living costs, then the tax advantage of incorporation will narrow significantly.

Transferring existing rental properties into a company

This is where things get complicated and become expensive, even technically risky. Incorporating a property company is best done with newly purchased properties where the company buys the properties from a third party.

Transferring a personally owned property to your own company is treated as a sale at market value and repurchase by the company, even when no money changes hands. This has major tax consequences.

Capital Gains Tax (CGT) 

There could be a Capital Gains Tax (CGT) liability if the current market value is above what you originally paid. CGT is payable on the current market value, less the original purchase cost and minus allowable costs (legal fees, improvements etc). Residential property gains are taxed at 18 per cent (basic) and 24 per cent (higher) with a £3,000 tax-free allowance.

It is always possible that Incorporation Relief under s.162 TCGA 1992 may be achieved where the CGT payment can be deferred. But this is complicated. It only applies if you are transferring a genuine property business, the whole business is being transferred, and the consideration is wholly or partly in shares. Small-scale landlords often fail the “business” test as they are a passive rent collector, investors in the eyes of HMRC, not a business operator – they rarely qualify.

Stamp Duty Land Tax (SDLT)

The company must pay SDLT on the full market value when purchasing a property. This is often a deal-breaker for transfers. Residential rates apply, plus the 5 per cent additional dwelling surcharge. There is no automatic relief simply because you own both sides of the transaction.

In some cases, partnership incorporation rules may mitigate SDLT but these are complex and heavily scrutinised.

HMRC has issued strong warnings regarding several "aggressive" tax avoidance schemes being marketed to UK landlords aiming to move personally owned rental properties into limited companies. These schemes promise to eliminate Capital Gains Tax (CGT), Stamp Duty Land Tax (SDLT), and reduce Income Tax, but HMRC deems them largely ineffective and illegal.

Mortgage issues

If your property is mortgaged on transfer, the existing loan must be redeemed which often means early repayment charges are applied. A new company mortgage must be arranged with a mortgage company prepared to deal with company mortgages. It often means that personal guarantees are required and slightly higher interest rates apply.

There are legal and administrative steps involved in a transfer which will require the services of several different professionals to deal properly with issues including conveyancing, determining CGT and SDLT liability, arranging refinancing where appropriate and determining the market value of the property. Costs for these services could easily top £2,000-£3,000 plus.

Inheritance Tax (IHT)

Shares in a property investment company may, in some circumstances, qualify for Business Property Relief (BPR) after two years. However, HMRC’s long-standing position is that property investment businesses are generally considered investment businesses rather than trading businesses. This distinction is crucial as purely passive rent collection, even when it involves a considerable amount of work to run the rentals business, rarely qualifies.

Run a full-time, active, structured, service-heavy rental operation and you may have a stronger argument, but professional advice is essential here. BPR is by no means not automatic for a rentals business.

Family Investment Companies (FICs) are private companies designed to hold family assets (investments, property, cash), allowing in some cases, parents to transfer wealth to children while retaining control. 

By gifting shares to younger generations, future asset growth occurs outside the parents' estate, and the structure can avoid the 40 per cent IHT rate and initial 20 per cent trust charges. FICs are increasingly popular due to their flexibility in share classes, allowing for tailored income distribution, such as dividends for children.

This again is a complex area where professional advice is crucial.

Who would benefit most from incorporation?

Portfolio landlords, those with multiple properties generating substantial profits and carrying significant mortgage debt are by far the greatest beneficiaries of incorporation. Section 24 has eroded margins for buy-to-lets in private ownership. A company restores cost deductibility and enhances after tax profits.

Higher and additional rate taxpayers benefit more than basic rate payers, also if their rental income pushes them into the higher rate bands. Long-term holding investors building up intergenerational portfolios, and reinvesting profits rather than extracting income, gain the most structural advantage.

Small-scale landlords with modest profits and those remaining within the basic rate band while wishing to extract profits to live off, will find the initial costs and ongoing administrative burden may outweigh any tax savings.

Transferring existing properties will make many projects unviable. All the complexities and costs involved are often prohibitively expensive unless structured very carefully, for example with incorporation relief under specific conditions, so professional advice here is essential.

The bottom line on incorporation

The rise in incorporation is far from speculative behaviour on the part of the increasing number of landlords doing it, it is rational tax planning in response to the way tax policy has worked against buy-to-let landlords. But structure is vital. 

If you are building a leveraged portfolio, reinvesting profits, and operating on higher income tax band rates, a limited company can materially improve after-tax returns.

However, for most small-scale landlords with existing privately owned (one or two properties) and you are relying on the rental income for day-to-day living, the advantage may be marginal at best.

Every situation is different, so the advice is, seek specialist professional advice before doing anything. Run the numbers past them. Model the cashflows. Understand your exit strategy.