Emma, a sole beneficiary of her late mother’s estate worth £2 million after accounting for Inheritance Tax, is planning to build up a mortgage-free rental property portfolio worth £1.5 million. Currently, she has a relatively good job at the age of 56, earning £48,000 per annum.
Assuming Emma will pursue her plans, here’s how her property portfolio would look like:
- 10 buy-to-let properties worth £150,000
- Average rent: £650 pcm
- Gross rent: £78,000
- Agency fees: 8% of gross rent
- Repairs and maintenance: £5,760 per year
- Rental profits: £66,000 every year
So, should she hold the properties personally or via a company?
Personal Tax Position v Company Tax Position
If she holds the properties personally:
- £66,000 worth of rental profits will be chargeable to her income tax each year
- Emma’s total income will increase to £114,000
- Personal allowance will be restricted to £4,000 based on her total income
- The additional tax attributable to the rental profit is £29,200 (an effective tax rate of 44.2%)
If the properties are held by the company:
- The corporation tax due would just be £13,000 (corporation tax of 20%)
- The tax saving by holding the properties through a company would be £160,000 when Emma becomes eligible for pension
Preserving v Extracting Profits In The Company
- She may preserve her rental profits in the company until she retires as she is currently receiving good income from her job and as well as the £500,000 residue of the estate.
If she wants to extract all of the profits through dividends and just hold the properties, anticipating a capital growth, she needs to consider the impact.
- Dividends each year would be £52,800
- Personal allowance restricted by £400
- Overall tax attributable to the rent would be £28,395 (£13,200 + £15,195)
This is a small saving of £800 per annum that she may use for costs of running the company such as the accountants. Therefore, there is little tax benefit using a company. However, there could still be some benefit to using a property management company.
Emma’s Pension Arrangement
If Emma decides to preserve her profits in the company until her retirement age of 66, the company option can be very useful. This is because she will be a basic rate taxpayer by the time she wants to access her funds.
- State pension entitlement: £8,000 per annum
- Take £35,000 of dividends per year to fully utilise her basic rate band as she has no private pension
- Tax of under £41,000
- Company bank balance continues to grow around £17,000 every year
Value of the Properties
Property value growth or decline varies from every location. Assuming the properties will have a moderate growth of 2% per year, there will be a gain of £328,000 by the time Emma retires. If she wants to cash in the properties, she would have to pay Capital Gains Tax.
Personal – CGT
- If she holds the properties personally and wants to cash in the properties at her retirement, CGT will be payable at 28%
Company – CGT
- If the properties are held by a company, the gain would be chargeable to corporation tax at 20% falling to 17% in 2020. The company will also benefit from the availability of indexation to reduce the gain chargeable.
Emma’s company will have £1.83 million worth of capital assets and £528,000 in cash including capital growth if she decides to preserve her profits. In addition, if she followed the mentioned pension arrangement, the profits will increase by around £17,000 per year. The shares won’t qualify for business property relief and so there is going to be an Inheritance Tax issue.
To plan for her IHT, Emma can use her company as an effective way of saving tax as shares are generally easier to divide up amongst her children than a legal share of the properties.
There is a clear tax benefit to using a limited company as an investment vehicle as she has a relatively high number of properties in the portfolio and her situation means that it is less likely that she will need much of her generated income from rentals.
There won’t be as much benefit using a company if all her income will be extracted every year. Nevertheless, using the company as an alternative to a pension or as an IHT planning tool could yield to substantial benefits for Emma.
If you have a similar situation or you need any property tax advice, call us at 01172 788200 to book a free initial consultation.