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Should You Build a Rental Portfolio Through a Limited Company? Pros and Cons for Landlords

Mon 09 Sep 2024

Since 2017, the number of Limited Companies set up by landlords has tripled, with over 300,000 recorded in 2022. Around 40% of new buy-to-let purchases now use a company structure. This shift, driven by tax changes introduced under Section 24 in 2020, has led many landlords to reconsider how they own and manage their properties. But is this the right move for everyone? Let’s explore the pros and cons of operating your rental portfolio through a Limited Company.

What is Section 24, and Why Did it Change Landlords' Tax Landscape?

Section 24 significantly altered the way landlords were taxed on their rental income. Previously, landlords could deduct mortgage interest payments and other expenses before being taxed on profits. Now, under Section 24, landlords can only claim basic-rate tax relief (20%) on mortgage interest, leaving many higher-rate taxpayers facing much larger tax bills. This led to a surge in landlords setting up Limited Companies to better manage their tax exposure.

Pros of Setting Up a Limited Company

  1. Reduced Tax Liability: One of the biggest incentives for landlords to switch to a Limited Company is the potential tax savings. Instead of paying income tax on profits (which could be up to 45% for higher-rate taxpayers), the company pays Corporation Tax, currently at 25%. This can result in substantial savings for landlords with significant rental income.
  2. Limited Liability Protection: Operating through a Limited Company offers personal liability protection. The properties and any associated debts are owned by the company, meaning that landlords' personal assets are protected in case of financial issues or creditor claims.
  3. Greater Flexibility in Profit Management: Limited companies offer more flexibility when managing profits. You can retain profits within the company, reinvest them into additional properties, or pay yourself through dividends, which are taxed at a lower rate than income. This can be particularly useful for growing a property portfolio.
  4. Inheritance Planning: Transferring ownership of a property portfolio is easier and potentially more tax-efficient through a Limited Company. Passing on shares in a company is often simpler and may help reduce liabilities such as Stamp Duty and Inheritance Tax.

Cons of Operating as a Limited Company

  1. Not Tax Efficient for Basic-Rate Taxpayers: If you fall into the basic income tax bracket, Section 24’s impact is much smaller. Therefore, setting up a Limited Company might not provide enough tax benefits to justify the associated costs and administrative burden.
  2. Selling Properties to the Company Involves Costs: Moving existing properties into a Limited Company is treated as a sale, which means paying Stamp Duty and potentially Capital Gains Tax. Many landlords choose to hold existing properties personally while acquiring new ones through the company to avoid this.
  3. Additional Administrative Responsibilities: Running a Limited Company comes with more complex legal and financial responsibilities. Annual filings with Companies House, preparing company accounts, and submitting Corporation Tax returns will likely require professional help, often costing over £1,000 per year.
  4. Double Taxation: While the company pays Corporation Tax on profits, if you draw money out as a salary or dividends, you’ll pay personal income tax on those amounts. This can lead to a form of double taxation, eating into your overall returns.
  5. Higher Mortgage Rates: Limited Company mortgages tend to come with higher interest rates and fees compared to personal buy-to-let mortgages. There are also fewer mortgage products available, which could limit your financing options.
  6. No Capital Gains Tax Allowance: When selling a property as an individual, you benefit from a Capital Gains Tax allowance (currently £6,000). However, this allowance does not apply when selling properties through a company. While Corporation Tax is lower, this lack of an allowance could still be a drawback.

  7. Conclusion

Setting up a Limited Company for your rental portfolio can offer significant tax and inheritance planning benefits, especially for higher-rate taxpayers and those with larger portfolios. However, it does come with additional administrative costs, potential double taxation, and higher mortgage rates. For landlords with smaller portfolios or those in the basic tax band, the advantages may not outweigh the costs. As always, it’s essential to consult with a financial advisor to determine the best structure for your personal circumstances.