Incorporating an HMO into a Limited Company: Pros and Cons

Over the past decade, Houses in Multiple Occupation (HMO) properties have gained significant popularity in the UK rental market. Unlike traditional rental businesses, HMO landlords rent out properties to multiple tenants from different households, creating a more diverse source of revenue for the landlords. With their strong potential for a large income stream, becoming an HMO landlord may seem like a no-brainer. However, operating HMOs comes with significant obligations, both towards tenants and the government, as HMOs are under the scrutiny of the housing authorities in the UK.

Once a decision is made to become an HMO landlord, the next critical decision is choosing the right ownership structure for your HMO property—whether to operate as a sole trader, a partnership, or through a limited company. Each ownership structure has its own set of advantages and drawbacks that need to be carefully weighed before making a final decision. Furthermore, the income reporting obligations and deadlines for income tax filings will vary depending on the chosen structure.

While this article focuses on HMOs through limited companies, we also have a separate article dedicated to operating HMOs through partnerships. Feel free to explore it!

Pros of Transferring an HMO into a Limited Company

Individuals and landlords in partnerships pay taxes on the rental income at personal tax rates, ranging from 20% to 45%. However, limited companies pay corporation tax that ranges from 19% to 25% depending on the total taxable profits of the company, with a profit between £50,000 and £250,000 getting a marginal relief.

The rental income from HMO will be taxed at the following rates if the HMO is operated as a sole trader.

However, the tax rates are comparatively lower if individuals decide to incorporate the HMO business.

Comparing the two tables, it seems obvious that companies pay taxes at lower rates than the sole traders and those in partnerships. In addition to tax savings, incorporating also offers flexibility in mortgage interest deductions.

Mortgage Interest Deduction

A huge benefit of operating a rental business via a limited company is their flexibility on mortgage interest deduction. Since the introduction of section 24 for rental property businesses in 2017, individual landlords and partnerships cannot deduct the mortgages paid to arrive at their taxable income. Instead, a ‘basic rate tax relief’ is given. However, the restriction does not apply to companies. Therefore, landlords are opting to operate their HMO property via limited companies to continue enjoying the benefits of mortgage interest deductions in full.

The functionality and implications of this restriction are explained in our complete guide to Mortgage Interest Tax Relief.

Effective Inheritance Tax Planning

Companies have a relatively broader option for inheritance tax planning than individuals. One of these is the family investment company, which is an inheritance tax plan to shield personal assets from potential creditors and legal challenges. With careful planning, a comprehensive and effective inheritance plan can be developed to meet your specific needs and goals.

Cons of Becoming an HMO Landlord via a Company

License Requirement

Incorporating an HMO into a limited company can offer significant benefits, including lower tax rates, full mortgage interest deductions, and more effective inheritance tax planning. However, it's essential to weigh these advantages against the potential drawbacks, such as licensing requirements, council tax obligations, and the impact of taxes like SDLT and CGT.

Each landlord's situation is unique, and careful consideration of these factors will help determine whether incorporation is the right choice.

HMO properties are under the scrutiny of the government given the weight they carry in the UK housing sector. Therefore, becoming an HMO landlord is not always straightforward, irrespective of the ownership structure. Depending on the number of occupants in the HMO, different types of licenses may be required. We cover the specific licensing requirements in detail in our article on HMO rules for landlords.

An application for an HMO license must be submitted to the local council, and once approved, each license is valid for five years. Licensing fees vary by council and are often determined by the property's size and location, with larger properties typically incurring higher costs. Generally, the payment structure involves an initial fee at the application stage and a final payment upon issuance of the license. For example, in Fulham, a mandatory HMO license for a 5-bedroom property costs £1,300, plus an additional £160 for each extra bedroom. An additional HMO or Selective license comes with a fee of £560.

Running an HMO letting business without a valid license can result in unlimited fines.

Council Tax

Council tax is another charge that property owners in the UK must pay. Unlike most taxes, the council tax is collected by the local councils and used to fund local services. While the tenants generally pay the council tax, the changes in The Council Tax Regulations have altered the dynamics of council tax responsibility for HMOs.

Under the updated regulations, an HMO is now treated as a single dwelling for council tax purposes. Notably, the obligation to pay council tax has shifted from the resident to the owner. It's crucial to emphasise that self-contained flats are exempt from these new regulations, preserving the previous framework for this specific type of accommodation.

Annual Tax on Enveloped Dwellings (ATED)

The Annual Tax on Enveloped Dwellings (ATED) is a tax regime introduced by the UK government to address tax avoidance in property ownership, particularly targeting properties held within corporate structures. This annual tax is levied on UK residential properties, such as HMO properties that are valued above £500,000 and owned by "non-natural persons," mainly companies.

The amount of ATED payable varies depending on the property's value, either at the time of purchase or as of 1 April 2022, whichever is later. Additionally, properties must be revalued every 5 years from 1 April 2022.

Where the company is a non-resident company, or is controlled by non-residents, a 2% surcharge is added to the SDLT rate, with the figure ranging from 5% and going as high as 17%.

When the value of the HMO exceeds £1.5 million, companies are typically required to pay SDLT at 15% of the property’s value. However, HMRC offers reliefs allowing companies to pay SDLT at standard rates, as outlined in the above table, to certain types of businesses, including those involved in property rental and property development, among others.

Capital Gains Tax (CGT)

Capital Gains Tax (CGT) is triggered on transactions involving an asset that has increased in value. For individual landlords transferring their HMO property to a limited company, CGT is a tax that must be considered.

When a trading business is transferred or sold, such as furnished holiday lets (FHL), such disposals qualify for the Business Asset Disposal Relief (BADR) and, therefore, pay only 10% on the gain up to £1 million. However, the transfer of HMO property is unlikely to be considered a trading business, and therefore, the BADR is unlikely to apply. Instead, the transfer of HMO to a company will be subject to CGT at the normal rates on residential property, ranging from 18% to 24%.

One way to defer the immediate impact of the capital gains tax (CGT) is by claiming the Incorporation Relief. This relief is offered to individuals or partnerships who transfer their business assets to a company in exchange for shares during the process of incorporation. Transactions qualifying for the relief do not have to pay either the CGT immediately. Instead, the capital gain arising is held over into the base cost in the shares of the company, delaying the capital gains tax liability.

Conclusion

Incorporating an HMO into a limited company can offer significant benefits, including lower tax rates, full mortgage interest deductions, and more effective inheritance tax planning. However, it's essential to weigh these advantages against the potential drawbacks, such as licensing requirements, council tax obligations, and the impact of taxes like SDLT and CGT.

Each landlord's situation is unique, and careful consideration of these factors will help determine whether incorporation is the right choice.