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Having a basic understanding of property investment tax is essential for an investor to attain optimum returns and limit tax liabilities. This is also, where a good property accountant can come in handy.
In recent years, there has been a rise in limited companies for property investment as an alternative to personal ownership. In this post, we’ll dive into the complexities of this trend and its implications on real estate taxes.
We’ll start by discussing rental income calculations and allowable expenses that can be deducted from your taxable income. Following that, we’ll explore how Section 24 impacts mortgage interest treatment for higher-rate taxpayers who own properties personally.
Moving forward, you’ll learn about the advantages of owning investment properties through a limited company structure, including lower corporation tax rates on rental profits and greater flexibility in profit distribution and reinvestment strategies.
Finally, we’ll weigh the pros and cons of personal versus limited company ownership when it comes to Property Investment tax considerations.
The Rise of Limited Companies for Property Investment
Recently, there has been a surge in the number of property investors opting to purchase properties through limited companies, due to differences in tax treatment between personally owned and company-owned investment properties. Understanding these distinctions can help you make an informed decision about whether investing through a limited company or personally is best suited for your goals.
Why Investors are Choosing Limited Companies
There are three primary reasons why an investor might choose to invest in real estate through a limited company, namely:
- Tax advantages: Operating as a limited company offers potential savings on taxes compared to personal ownership, particularly when it comes to mortgage interest deductions and corporation tax rates.
- Asset protection: A limited company structure provides an additional layer of legal separation between your personal assets and those held by the business, which can be beneficial in case of financial difficulties or disputes with tenants.
- Growth opportunities: Owning property within a limited company allows you to reinvest profits more efficiently than if they were subject to higher personal income tax rates. This can lead to faster growth and expansion for your portfolio.
If you’re considering making the switch from personal ownership to operating under a limited company structure, it’s essential to consult with experienced professionals like our team at BrooksCity who specialize in property accounting services.
They will provide valuable guidance tailored specifically towards achieving success within this increasingly popular area of investment.
Rental Income and Allowable Expenses
To understand the tax implications of owning property personally versus through a limited company, it’s essential to know how rental income and allowable expenses are calculated.
Rent received from tenants and associated expenses such as mortgage interest payments, utility bills, service charges, letting agent fees and general maintenance costs are important components of calculating your overall tax liability.
These factors will play a crucial role in determining your overall tax liability as either an individual or a corporate property owner.
Calculating Rental Income
Your rental income is simply the total amount you receive from your tenants each month. It’s important to accurately track this figure for taxation purposes. Many landlords use HMRC-approved accounting software or enlist the help of an accountant to ensure they’re correctly reporting their earnings.
Deducting Allowable Expenses
Allowable expenses can be deducted from your taxable rental income before calculating any taxes owed. Some common examples include:
- Mortgage interest payments (for limited companies)
- Utility bills paid by the landlord
- Service charges and ground rent on leasehold properties
- Fees charged by letting agents for managing properties
- Maintenance costs such as repairs or improvements made to maintain living standards
It’s essential that you keep accurate records of all these expenses so that you can claim them against your taxable profits when filing your annual self-assessment tax return.
Mortgage Interest Treatment – Section 24 Impact on Personal Ownership
One critical difference between personal ownership and operating under a limited company structure lies in how mortgage interest is treated for taxation purposes.
For higher-rate taxpayers who own their investment properties personally, Section 24 legislation significantly reduces potential financial rewards by limiting mortgage interest deductions against taxable profits, resulting in increased taxes compared with basic rate taxpayers.
How Section 24 affects higher-rate taxpayers
Prior to the introduction of Section 24, landlords could deduct all their finance costs from rental income before calculating tax liability. However, since April 2017, this relief has been restricted to just a basic tax credit (currently at 20%) regardless of the taxpayer’s actual marginal rate.
This change disproportionately impacts those who personally own property as they can no longer offset their full mortgage interest expenses against rental income.
Corporation Tax Advantages for Limited Company Owners
A key benefit of owning investment property through a limited company comes from paying corporation tax instead of personal income tax rates on profits earned from rentals. Currently set at 25% or 19% if you qualify for Small Profits Rate of 19% which means your company has profits of profits of £50,000 or less.
Corporation tax offers substantial savings when compared with high-income earners’ marginal rates which could be as much as 45%. Furthermore, after-tax profits within the Limited Company can be reinvested more efficiently or distributed as dividends.
Flexibility in Profit Distribution and Reinvestment
Beyond the immediate benefits of lower taxes, operating under a limited company structure also provides flexibility when it comes to distributing and reinvesting profits.
As opposed to being taxed directly on all rental income received personally, any retained earnings within the Limited Company can be used strategically for future growth opportunities such as acquiring additional properties or improving existing ones without facing immediate personal taxation consequences.
Additionally, shareholders have the option to receive their share of profits via dividends, which may attract different tax treatment depending on individual circumstances.
Weighing the Pros and Cons of Personal vs. Limited Company Ownership
When considering whether to invest in property personally or through a limited company, it’s crucial to weigh up all the advantages and disadvantages. When making this decision, it is important to consider factors such as income level, investment goals, plans for growth and overall financial situation. Seeking professional advice can be beneficial in helping to decide which ownership structure is best suited for your individual situation.
Assessing Personal Income Levels
Your personal income tax bracket plays a significant role in determining which ownership structure is more advantageous for you. Higher-rate taxpayers may find that investing through a limited company offers substantial tax savings compared to owning properties personally due to lower tax rates.
Evaluating Long-Term Property Investment Strategies
Here are three key areas to consider when deciding on your real estate investment strategy.
- Growth Potential: If you plan on expanding your property portfolio over time, operating under a limited company structure may offer greater flexibility in reinvesting after-tax profits without being subject to higher personal income tax rates.
- Risk Management: Owning properties through an company can also provide some protection against potential liabilities associated with individual ownership by separating business assets from personal ones.
- Inheritance Planning: Transferring shares within a limited company can be simpler than transferring multiple individually-owned properties when planning for inheritance purposes.
To make an informed decision about whether investing personally or via a limited company is best suited for your goals, consult with property accountant first who can provide tailored advice for your specific situation.
Investing in property can be a lucrative venture, but it’s important to understand the tax implications that come with it. Limited companies are becoming increasingly popular for property investment due to their tax advantages, including lower rates on rental profits and flexibility in profit distribution and reinvestment.
When considering personal versus limited company ownership, it’s crucial to assess your personal income levels and evaluate long-term investment strategies. Additionally, understanding how rental income is calculated and deducting allowable expenses can help maximize profits.
Don’t neglect the significance of property investment tax when investing in real estate. Consider consulting with a professional accountant or financial advisor to determine which ownership structure best suits your needs.
Ready to start investing? Contact BrooksCity today for expert advice on managing your finances and maximizing returns through strategic investments!