Incorporating a buy-to-let

Salemicus

Hi all,

I am looking for advice on whether it makes sense to incorporate a buy-to-let investment. I've gone through some numbers below, and I'd love some advice on whether these make sense, and on whether the assumptions I'm making are sensible, or if I'm leaving lots of things out.

Thanks in advance!

The idea is an ordinary repayment mortgage on my main home at a notional 2%, to buy two properties at a cost of ~£230k each, with a rental income (conservatively) of £900pcm. My wife and I are 40% taxpayers. Assume we're already under the full 2020 rules for simplicity:

Purchase cost: £230k * 2 = £460k
Fees: £18k stamp duty + misc = ~£20k
Annual Interest: (460k + 20k) * 2% = £9600
Annual Rent: £900 * 12 * 2 = £21.6k
Only account for 90% of the rent in case of gaps, etc, so:
Accounted rent: £21.6k * 0.9 = £19440
Expenses at notional 15%: 19440 * 0.15 = £2916

Personal:
Taxable profit = 19440 - 2916 = £16524
Interest relief = 9600 * 0.2 = £1920
Tax payable = £16524 * 0.4 - £1920 = £4689.6
Net annual profit = 16524 - 4689.6 - 9600 = £2234.40

Incorporated:
Accountants fees = £800
Taxable profit = 19440 - 2916 - 9600 - 800 = £6124
Tax payable = £6124 * 17% = £1041.08
Net annual profit = 6124 - 1041.08 = £5082.92

Which, as it's less than £10k, my wife and I could draw out as dividends tax-free so would incur no further tax.

Then on asset disposal... suppose properties both sold 5 years later, with 20% capital appreciation (this is deliberately setting the capital growth high to make the tax consequences worse... I don't necessarily expect anything like that, but obviously in the event of no or minimal capital growth, there's no tax to pay so this section is not interesting).

Suppose the indexation allowance for the next 5 years turns out to be 0.126 (just a guess, but needs something, and this is what it was over the past 5 years).

After 5 years, the outstanding mortgage balance will be £402k, meaning the company owes £402k to the bank and £78k to me (as I am loaning it the principal repayments, interest free).

Sale price: £552k
Original price: £460k
Fees: £20k

Personal:
Capital gain: 552 - 460 - 20 = £72k
CGT allowance: 11.3k * 2 = £22.6k
Tax payable: (72 - 22.6) * 0.28 = £13,832
Profit: 72k - 13832 = £58,168

Incorporated:
Chargeable gain: 552 - 460 - 20 - (480 * 0.126) = £11,520
Tax payable: 11520 * 17% = £1958.40
Assets held by company: 552k - 402k - 1958.4 = £108,041.6
I can take back my loan to the company without paying any tax, then:
Assets held by company: 108041.6 - 78k = £30041.6
Pay £5k dividend to me and my wife tax free.
Assets held by company: £20041.5
Assets under £25k, so can close down company and take its assets tax-free.
Profit: 72k - 1958.4 = £70,041.6

So basically, incorporating looks substantially better, both for rental income and capital gains (if any). Is there stuff I'm missing or overlooking here (beyond the obvious fact that all these rules may well change over the next 5 years)?

anselld

The obvious pitfall is dividend allowance is scheduled to reduce to £2k from April 18.

CT is currently 19% and may go down to 17% *if* the current Goverment survives and doesn't change its mind..

00ec25

in whose name is the mortgage?

for the company to claim the interest then the loan must be in its name, yet you state that the loan will be against your own residential home. So how sure are you that the company can get such a loan at 2% secured on an asset that the company does not itself own?

if the mortgage loan is in your personal name, then the company has no interest charge to claim, unless you (personally) charge the company interest yourself on the director's loan you have made to it (or, playing with words, the company agrees to pay its director interest on the money it has borrowed from the director). Such interest rate must be "commercial equivalent", not exploitative, and must relate to borrowings used for the trading purposes of the company. The latter of course not being a problem in this case as it is self evident how the debt has been used. However, that would then be taxable income on your personal self assessment (subject to the £500 personal savings allowance of course) so will somewhat skew your bottom line

as for the CGT calculation, you have a typo: 552 - 402 - 1.9584 = 148,041.60 not 402k
if the loan is in your name, then the company reserves after CT payment comprise £550,041.60, of which 480,000 is the director loan account which can be withdrawn penalty free. However that leaves company reserves of 70,041.60, not the 30,041.60 you have written. You can't close the company down in a single swoop to use the 25k allowance, you'd need to run it down over time.

saajan_12

Salemicus wrote: »

Hi all,

I am looking for advice on whether it makes sense to incorporate a buy-to-let investment. I've gone through some numbers below, and I'd love some advice on whether these make sense, and on whether the assumptions I'm making are sensible, or if I'm leaving lots of things out.

Thanks in advance!

The idea is an ordinary repayment mortgage on my main home at a notional 2%, to buy two properties at a cost of ~£230k each, with a rental income (conservatively) of £900pcm. My wife and I are 40% taxpayers. Assume we're already under the full 2020 rules for simplicity:

Purchase cost: £230k * 2 = £460k
Fees: £18k stamp duty + misc = ~£20k- buying costs I'd assume stamp duty £9k x2; legals / disbursements £1k x2; mortgage fees + main home valuation £1k; survey £500 x2 ->
Total buying costs £22k
Annual Interest: (460k + 20k) * 2% = £9600-
this would go down over time on a repayment mtg, so tax relief would decrease
Annual Rent: £900 * 12 * 2 = £21.6k
Only account for 90% of the rent in case of gaps, etc, so:
Accounted rent: £21.6k * 0.9 = £19440- wise
Expenses at notional 15%: 19440 * 0.15 = £2916

Personal:
Taxable profit = 19440 - 2916 = £16524
Interest relief = 9600 * 0.2 = £1920
Tax payable = £16524 * 0.4 - £1920 = £4689.6
Net annual profit = 16524 - 4689.6 - 9600 = £2234.40

Incorporated:
Accountants fees = £800
Taxable profit = 19440 - 2916 - 9600 - 800 = £6124- the mortgage is in your personal name, so the company can't claim it as an expense. Unless you lend the same amount to the company at 2% interest, but then you pay tax on the interest personally above the £500 allowance.
Tax payable = £6124 * 17% = £1041.08 I make it £15724 * 17% = £2673
Net annual profit = 6124 - 1041.08 = £5082.92Company profit £13051. Dividends above £10k taxed at 32.5% so £992 dividend tax.
Net profit £13051 - £9600 personal interest - 992 dividend tax = £2459


Which, as it's less than £10k, my wife and I could draw out as dividends tax-free so would incur no further tax.

Then on asset disposal... suppose properties both sold 5 years later, with 20% capital appreciation (this is deliberately setting the capital growth high to make the tax consequences worse... I don't necessarily expect anything like that, but obviously in the event of no or minimal capital growth, there's no tax to pay so this section is not interesting).

Suppose the indexation allowance for the next 5 years turns out to be 0.126 (just a guess, but needs something, and this is what it was over the past 5 years).

After 5 years, the outstanding mortgage balance will be £402k, meaning the company owes £402k to the bank and £78k to me (as I am loaning it the principal repayments, interest free).

Sale price: £552k
Original price: £460k
Fees: £20k

Personal:
Capital gain: 552 - 460 - 20 = £72k
CGT allowance: 11.3k * 2 = £22.6k
Tax payable: (72 - 22.6) * 0.28 = £13,832
Profit: 72k - 13832 = £58,168

Incorporated:
Chargeable gain: 552 - 460 - 20 - (480 * 0.126) = £11,520
Tax payable: 11520 * 17% = £1958.40
Assets held by company: 552k - 402k - 1958.4 = £108,041.6
I can take back my loan to the company without paying any tax, then:
Assets held by company: 108041.6 - 78k = £30041.6
Pay £5k dividend to me and my wife tax free.
Assets held by company: £20041.5
Assets under £25k, so can close down company and take its assets tax-free.
Profit: 72k - 1958.4 = £70,041.6

So basically, incorporating looks substantially better, both for rental income and capital gains (if any). Is there stuff I'm missing or overlooking here (beyond the obvious fact that all these rules may well change over the next 5 years)?

Be careful with the company claiming interest costs that you actually personally incur.

Salemicus

No no, I wouldn't want the mortgage to be in my personal name, otherwise, as you say, I'd not be able to deduct interest.

Idea would be for the company to borrow the money, but with me guaranteeing the loan and providing the security. Would a lender not go for that?

00ec25

Salemicus wrote: »

Idea would be for the company to borrow the money, but with me guaranteeing the loan and providing the security. Would a lender not go for that?

ask a broker

lots of companies do of course borrow money against personal guarantees from a director. Whether that gives the lender any acceptable security is down to their individual risk appetite since the security for the loan is not directly tied to the lender's ability to force the sale of director's own house as the lender does not have a charge over it since the house is not the actual security for the loan, that is instead the guarantee,

And guarantees have a habit of going up in smoke when it transpires the director actually has no assets in his own name as he transferred them all to his wife....

saajan_12

Salemicus wrote: »

No no, I wouldn't want the mortgage to be in my personal name, otherwise, as you say, I'd not be able to deduct interest.

Idea would be for the company to borrow the money, but with me guaranteeing the loan and providing the security. Would a lender not go for that?

At (much) higher interest rates if at all. I would think either

A. Company has a mortgage with the lender placing a charge on a property owned by the company, on a BTL basis (with you guaranteeing) and slightly higher interest rates; or

B. Company has an unsecured loan with a guarantee / collateral from you at much higher interest rates;

Even if you find A / B / what you suggest, you would have limited options for lenders given the lack of trading history of the company. The best of a smaller pool can't be better than the best of a bigger pool of options. i.e. you're likely to have go to with whatever you get.

SouthLondonUser

You really need to speak to a mortgage broker to get a feeling for what options might be available. Many lenders charge heavy upfront arrangement fees when lending to a ltd company, so you must really do your maths carefully.

Also, don't go for too short a deal; if you get, say, a two-year fix, you are exposed to the risk that refinancing in two years might be more difficult, because who knows what the market will be like then, and especially who know how many lenders would be willing to lend to an ltd then, and on what terms.

Salemicus

The obvious pitfall is dividend allowance is scheduled to reduce to £2k from April 18.

Ah, didn't know that. So instead I set up the company with my brother, with class A of shares owned by me, class B owned by my wife, class C (with no voting rights) owned by him. The company has no assets yet, so shares worthless. He creates a bare trust for my kids and puts the class C shares in it. Then I start running the company, and can pay up to (Personal Allowance + Dividend Allowance) * num_kids in dividends to class C shareholders per year.

Distinction between Class A and Class B is for future-proofing in case of e.g. differential incomes.

Does that work?

00ec25

since you are obviously well versed on taxation, why are you not getting this sorted out in a single session with your accountant? For the sums of money you are experimenting with, and the sophistication of the proposals, just pay for advice and get it right first time rather than trying to do it cheap on the net where only partial info can be considered.

Salemicus

I am by no means well-versed in taxation, and I don't have an accountant - all I've done is google around a bit like anyone would. (Well, like anyone sensible would, but I've seen enough threads here to know that not everyone has common sense...)

You are quite right that before actually doing anything I would take professional advice, but before doing that I thought it's best to think more generally about whether the underlying idea makes sense. I at least have found this thread super-helpful, and would be very grateful for any more advice. My tentative conclusions are:

1) that there are probably substantial tax advantages to incorporation, but
2) these could easily be outweighed by a bank charging higher interest.

I particularly don't understand (2). Several people (including you!) seem to suggest that if I guaranteed the company's loan then it would be unsecured. Why is that? The whole point is to have a secure mortgage loan.