Should you incorporate to save on tax?

Growing numbers of buy-to-let landlords are forming limited companies to negate the tax changes hitting the private rental sector from April 2017. The first nine months of 2016 saw more than 100,000 limited company mortgages issued, more than twice the total amount for the whole of 2015, according to the latest Buy To Let Britain report from mortgage lender Kent Reliance. However, despite its increasing popularity, incorporation will not be the best option for everyone.

The government has certainly succeeded in making buy-to-let a lot less appealing than it once was. Following on from last year's stamp duty increase, in April this year the Treasury will start phasing in changes that will eventually see tax relief on rental income cut to 20% for private buy-to-let landlords.

This will eat into the profits of higher earners who previously qualified for relief at 40% or 45%. New affordability checks introduced on 1 January 2017 will also mean that landlords borrowing in a personal capacity are less likely to be able to borrow as much against a property as they were previously, says David Whitaker of Mortgages for Business, a specialist mortgage broker.

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By contrast, incorporated landlords will be exempt from the coming tax hike because they pay corporation tax, currently charged at 20%, instead of income tax. They can also continue to deduct all their costs including finance from rental income for tax purposes. For those looking to incorporate, the process is fairly straightforward, and can be done online with Companies House for £12. Keep in mind that the company will need at least one director and must be registered for corporation tax.

However, there are some drawbacks to forming a limited company to run your buy-to-let business. "Many mortgage lenders don't offer buy-to-let mortgages for limited company lending so the choice of deal is more limited," says David Hollingworth of mortgage broker London & Country. "The rates on offer from a specialist lender can be higher, although it will be interesting to see if any more lenders are tempted to alter their approach if there is growth in limited company lending."

Running a limited company also involves a lot of administration. If you hire staff, you'll need to run a pay-as-you-earn (PAYE) salary scheme and workplace pension. You will also need to file company accounts and company tax returns as well as your own self-assessment tax return and company accounts. You will almost certainly need to engage an accountant for this, at a cost of several hundred pounds per year.

It is also important to consider the tax impact of transferring your existing properties into the limited company structure. "If you move properties you currently own as an individual into a limited company you'll be liable to pay capital-gains tax [CGT] on any gains made on the property, as well as stamp duty," warns Rob Bence, co-founder of The Property Hub, a property investors' forum.

In addition, those who own any property worth more than £500,000 should consult a tax adviser to see if the annual tax on enveloped dwellings (ATED) a tax designed specifically to discourage people from holding property within a company structure would apply to them.

You also need to think about how you will take income from the company. Any salary drawn above the standard tax allowances would be subject to income tax and employee's and employer's national insurance (the latter paid by the company). You may wish to take income as a combination of salary and dividends (the latter have favourable tax treatment). And if you eventually decide to exit the market, you'll need to come up with a strategy for extracting the value of your business as tax-efficiently as possible. Hence landlords should consult both an accountant and mortgage broker on what is the best option in their situation.