Property Taxation and Its Implications
The most easily understood way for an individual to invest in property directly is a buy-to-let residential property.
This can be dealt with in the self-assessment tax return quite simply by adding up rental income and deducting allowable expenses and deriving a trading profit to which income tax applies. The biggest disallowed expense is mortgage principal payments, that is the element of the mortgage payment that goes to reducing the size of the borrowed amount. The mortgage interest element is deductible. However the treatment of this tax relief has changed from the 1st April 2017 meaning that it is not taken off as an expense but as a basic rate deduction, meaning that if the owner is in higher rate tax they will be worse off once it comes fully into effect in 2020. Another thing to consider when calculating the trading profit is if the expenditure is capital or expenditure. Capital spend increases the value of the asset (the property) such as improvements whereas repairs and maintenance, which maintain the value of the asset are allowable as expenditure. Thus, if an investor buys a dilapidated property and brings it into an inhabitable state, that improves the value of the property and this spend is not tax deductible. The Wear and Tear Allowance has also been abolished, so you need good records of replacement items.
So what is the best way to invest in property then, as an individual or via a limited company? The answer is not clear cut and depends on your personal circumstances as there are benefits and costs to both approaches. If you are a higher rate tax payer you will be taxed on your income as an individual at 40%. The changes to tax relief on finance costs could indeed push people into this bracket, which would also have implications if they received child benefit. However, the level of corporation tax if the company was purchased via a limited company is 19% and is set to reduce to 18%. Thsi may mean more surplus money to repay the mortgage with. But this is not the end of story by far. If you wished to withdraw the money from your limited company and you paid dividend tax at the higher rate (32.5%) this means less take home income than investing in the property as an individual. Capital Gains Tax is chargeable at 18% or 28% for an individual whilst a gain would be charged at 19% and later18% for a company, meaning that on small gains there would not be a material difference but for larger gains a limited company would be more tax efficient. Also with inheritance tax there is a difference in treatment with a possibility of handing the limited company on to dependants if you receive some good advice. It is worth receiving some tailored advice to work out which route is best as it will differ on personal circumstances but generally, if you wish to live off the rental income in addition to employment income, the sole trader route is the way forward; if you wish to invest in property as a retirement plan and can time dividend payments and extraction of monies to when you have little or no employment income, then limited company would probably suit you best.
If you are a director of a limited company and you wish to reinvest surplus money into property, this is commonplace. Your bookkeeper & accountant must keep separate books, as you would anyway with different trades. You can add the income together, ignoring the losses, for tax reporting purposes.
As we've touched on the treatment of losses in this blog, this will be the subject of next week's post.