Profitability in the private rental sector hinges on a number of things, but achieving tax efficiency is a high priority. It’s the sensible and responsible decision. The right business structure for landlords lies at the heart of this and, niche as it sounds, it’s critical to your tax planning.
In this, the second part of our blog on tax planning for landlords, we look at the different business structures available and how individual circumstances should influence your choice.
Being profitable has always been important, but the hostile environment fuelled by the government is making this particularly difficult for landlords to achieve. Instead of cutting your losses and exiting the rental market, or just muddling along, we’re in favour of you taking charge of business and making it work for you.
Start by isolating your property business from the rest of your finances, then go for the structure that works best for you long term. Call it a reboot!
What are your financial plans?
In our first blog we asked the question “Where does a rental property fit into your financial plans?” This influences hugely the kind of business structure you could – and should – go for.
Do you want your property to provide an income, or to supplement current earnings? Maybe it’s a major part of your pension planning, or you might be thinking about handing over the reins to the next generation but fearing inheritance tax (IHT) … and quite rightly so! It’s important to know exactly what you want – or need – to do. Focusing on one thing, such as IHT, is likely to open up opportunities elsewhere and give you further ideas.
Clearly, your financial situation might make you scale down any ambitious dreams you might have … or even think bigger! So, our next question is …
What state are your finances in?
The current state of your finances is going to have a big influence on what you can achieve. For example, review and establish the following.
- Current CGT liability
- Qualifying interest
- Equity in your property portfolio
- Mortgage finance
If the outcome of this review indicates a less-than-positive financial status, don’t panic. It may simply mean that you need to pause your plans, in order to improve the value of your ‘estate’. Remember, the overall aim is to ring-fence potential liabilities. You may need a period of time to reduce debt or add assets to your property business. It’s just a matter of getting yourself in the best position possible so that you can select the structure that will work best for your particular property rental business.
Then, armed with a full understanding of your financial status and plans for your future, there are 3 main options available to you – and different ways of combining them.
Business structure options for landlords
A ‘business’ is simply a collection of people, so a structure can either be on an individual basis or as a corporation. A window cleaner, for example, is typically a ‘one-man-band’ operation, but they might choose to incorporate for reasons of tax efficiency.
For the landlord, there are 3 kinds of business structure:
- Limited company
- Partnership – eg LLP
So let’s help you understand which could work for you – either individually or combined.
Option 1: Limited Company
Transferring your property from private ownership into a limited company means that you pay corporation tax on profits at a flat rate of 19%, instead of income tax at 20% to 45%. You also avoid the Section 24 finance cost restrictions, because they don’t apply to limited companies. Essentially, a limited company offers a tax efficient way of extracting income from your own business. You keep your salary to the lower base rate and supplement with dividends (you can also choose to get holiday and sick pay!). Enthusiasm for this option has doubled in the last few years and now there is a significant market for limited company mortgages.
HMRC will consider this as a sale and purchase transaction, therefore capital gains tax (CGT) and stamp duty (SDLT) need to be managed. There are many ways of avoiding or reducing CGT, such as exchanging equity in the business for shares (often called ‘washing out’). If your CGT liability is particularly high, then moving abroad may be a way to reduce it (see below). Alternatively, reduce your debt, or add assets to the business. SDLT can be completely mitigated by incorporating a business partnership. Clever, eh?
If you have a portfolio of 6+ properties, work on the business at least 20 hours a week and have mortgage finance – then the limited company option is definitely worth a look, especially if you want to pass on your business as an inheritance.
Option 2: Limited Liability Partnership (LLP)
Partnerships were introduced in the UK in 1890 giving individuals the opportunity to work together in a business sharing income and risk. The Limited Liability Partnership (LLP) structure is more straightforward. It has to be registered (like a limited company), but generally assets remain owned by the individual partners. The ‘partnership’ structure simply allows income to be treated differently – for tax purposes. However, unlike a general partnership, an LLP allows you to distribute money to members disproportionately to their ownership, thereby reducing the profit and hopefully keeping partners to the basic rate of tax.
An LLP works well for a family business, because the members are more likely to have a closer affinity with one another and share the general aims of the business.
The distribution of profits, the return of capital, the introduction and removal of members are all possible without tax repercussions. Tax relief is available to ensure that CGT and SDLT don’t fall due either. Combine an LLP with a LTD and get the best of both worlds!
Don’t enter into an LLP if you plan to liquidate it at a later date simply to avoid paying tax such as CGT liabilities. HMRC has anti-avoidance principles and they will look at the bigger picture. If the reason for setting up an LLP is clearly motivated by tax avoidance, they will consider this an abuse of the system and act accordingly!
The other key consideration is that members of an LLP (family, friends or business partners) need to take an active role in the business.
Option 3: Move abroad
You might view this as a rather extreme option, unless it is your dream anyway – and for many, it is! Non residence can be a way to benefit from a lower tax status. Despite what you might think, it’s not necessary to move half way around the world either – how about sunny Portugal and paying no income tax or CGT for 10 years!
The right business structure for landlords depends upon the landlord!
Our years of experience mean we know how to select the right business structure for landlords.
As we said in our earlier blog, don’t do something because you think it might be a canny tax move. It could end up the exact opposite and you’d be no nearer achieving your future plans. In our experience, the right decision is much more likely if you are:
- Open minded – don’t reject an option without proper consideration.
- Strategic – take a landlord with 10 properties – they’re bound to have the odd ‘lemon’ in their portfolio. Incorporate the business, sell the lemons (to avoid CGT) and reinvest.
- Pragmatic – 10 properties shouldn’t mean 10 sets of legal fees!