When diving into property investment, many landlords and investors consider various strategies to maximise their returns and minimise their tax liabilities. Some companies and accountants in UK are promoting to buy each property through a separate company. However, this approach may not always be as straightforward or beneficial as it seems.
In this article, we’ll explore a real-life scenario, weigh the pros and cons of this strategy, and provide guidance on making the right decision for your property investments.
Real-Life Scenario: The Mortgage Broker's Warning
One of our clients, who was advised to start purchasing properties through a newly established company, encountered a roadblock. His mortgage broker informed him that lenders typically wouldn't offer loans to a new company without a track record. This advice was surprising, but it had significant implications for the client’s investment strategy.
As a result, instead of using the new company, the client had to revert to an existing company he already owned, which had an established track record. This situation raises a critical question: Is setting up a new company for each property purchase a viable strategy, or could it create more hurdles than it resolves?
Understanding the Mortgage Broker's Concern
The mortgage broker’s warning about lending to a new company isn’t unfounded. Many lenders are hesitant to finance newly formed companies because they lack a financial history, which increases the risk for the lender. This means that if you're considering setting up a new company for each property purchase, you may face difficulties securing financing. To avoid such issues, it’s crucial to consult with your mortgage broker before making any decisions.
Common Reasons Accountants Suggest Separate Companies
Accountants may recommend owning each property through a separate company for two primary reasons. Let's break them down and assess their validity:
1. Selling the Company Instead of the Property
One reason for this strategy is the potential tax advantage when selling. If you sell the property, the buyer will typically have to pay Stamp Duty Land Tax (SDLT), which can be quite significant.
However, if you sell the company that owns the property, the buyer might only pay 0.5% stamp duty on the shares, which is considerably lower.
Example,
Suppose you're selling a property valued at £500,000. The SDLT could be around £3,750 for the first-time buyers, £12,500 for the buyers buying their single and main home and £27,500 for the buyers buying the buy-to-let or second homes.
However, if the buyer purchases the company that owns the property, they might only pay £2,500 in stamp duty on the shares. This represents a substantial saving for the buy to let owners.
Counterpoint: While this sounds appealing, it’s not without its complications. In the example above:
- A first-time homebuyer cannot use a company to claim first-time buyer relief and would likely forgo this option’.
- Additionally, for those purchasing a property as their sole or primary residence, while they could save £10,000 on SDLT, they would then be subject to the Annual Tax on Enveloped Dwellings and would prefer a straightforward property transaction instead.
- The buy to let buyers may be reluctant to purchase the company due to the need for thorough due diligence, which could be costly and time-consuming. Further the pool of buyers willing to purchase the company instead of the company will be small.
2. Increased Fees for Accountants
Another reason companies and accountants may suggest separate companies is less about your benefit and more about their potential to charge higher fees. Managing the accounts and taxes for multiple companies, as well as producing group accounts, can result in significantly higher professional fees.
Example,
If you own five properties through five different companies, you’ll need five sets of accounts, tax returns, and possibly group accounts. The cumulative cost of this could far exceed the cost of managing a single company's accounts.
Counterpoint: If all your property is held within one company, your accountancy fees could be considerably lower. Consolidating your properties under one company reduces the administrative burden and associated costs.
Long-Term Strategy: What Should You Do?
Before deciding whether to set up a new company for each property purchase, it’s essential to consider your long-term property investment strategy. Here are some key factors to weigh:
Impact of Section 24
Section 24 of the Finance (No. 2) Act 2015 restricts mortgage interest relief for individual landlords. If you're holding properties personally, this could significantly impact your profitability. On the other hand, properties held within a company are not subject to these restrictions, which might make corporate ownership more attractive.
Tax Efficiency
While companies offer potential tax benefits, particularly concerning inheritance tax and income distribution, they can also be costly when it comes to extracting profits. Dividends, for example, are subject to taxation, and winding up a company or distributing assets can trigger tax liabilities. It's essential to weigh these factors before deciding on the corporate route.
Personal vs. Corporate Ownership
Personal ownership may be simpler and more cost-effective in some cases, especially if you're only dealing with a few properties and intend to sell them individually. On the other hand, if you’re planning to build a large portfolio, corporate ownership might offer more flexibility and potential tax savings.
Conclusion: Make Informed Decisions
Setting up a new company for each property purchase might seem like a smart strategy on the surface, but it’s essential to understand the potential pitfalls and long-term implications. Before making any decisions, consult with your mortgage broker to ensure you can secure financing and assess the additional costs and complexities involved with corporate ownership.
Ultimately, your decision should be based on a thorough analysis of your long-term goals, the impact of tax laws like Section 24, and the overall cost-effectiveness of the strategy. Property investment is a significant commitment, and making informed decisions will help you maximize your returns while minimizing risks and costs.
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