Income Tax For A Property Business 101

The downside of owning and managing buy-to-let property is that you may have to pay income tax. The taxes and national insurance a landlord pays vary depending on if the profits come from personal property or homes owned by a company. This primer explains the basics for both types of landlords.

Tax and NICs for individual landlords

Some intricate rules apply tax to individual landlords, and the rules differ for portfolio landlords operating their property businesses as limited companies.

Paying National Insurance

Most landlords believe they do not pay national insurance contributions (NICs), however much profit they make. This is not correct. Landlords who make profits of more than £6,515 a year and what they do to earn their money counts as running a property business must pay Class 2 NICs. What counts as running a business includes:

  • Managing your property as your main job
  • You rent out two or more properties as a portfolio.
  • You buy new properties to rent out.

Landlords making profits of less than £6,515 a year can opt to pay Class 2 NICs, for example, as payments towards their State Pension.

Paying income tax

How much tax you pay depends on whether you own your properties as an individual or a company. The first £1,000 of a landlord’s income is tax-free and called the property allowance. Landlords earning rents between £1,000 and £2,500 yearly should talk to HM Revenue & Customs about their tax affairs. Otherwise, landlords must file a self-assessment tax return if their properties earn them:

  • Between £2,500 and £9,999 after deducting business costs
  • £10,000 or more before deducting business costs

Landlords yet to register for self-assessment should tell HMRC about their rental income by October 5 in the year following that in which they earned the income. For example, landlords should report any rent received in May 2021 to HMRC by October 5, 2022.

Declare unpaid tax for previous years

If you have failed to declare unpaid tax on rental income from previous tax years, you can still file the details with HMRC under the Let Property Campaign. Under the campaign, landlords register with HMRC and get a three-month grace period in which they must work out and pay the tax they owe.

Tax for corporate landlords

Companies pay corporation tax on gains and profits rather than income tax, capital gains tax or NICs. Landlords then take money out of the company as workers on payroll or as dividends. 

The company deducts tax and NICs at the source the same way any other business pays workers. Directors and shareholders are paid a dividend based on the company’s level of profits, share value, and number of shares they own. Anyone owning shares picks up a £2,000 a year tax-free dividend allowance, which is added to the personal allowance when filing a self-assessment return.

What’s better, corporate or individual landlord tax?

Individual landlords tend to pay more tax on their rental profits than companies. That’s because HMRC regards rental profits as personal income. So if you work, you may find that your rental profits push your income into a higher tax bracket. Running your rental properties under the shelter of a company could mean a landlord pays less tax than operating as an individual. 

The main reason is while individuals gain a 20 per cent tax allowance for paying financial interest on mortgages and other credit, companies can claim the full amount of financial interest as a business cost. This does not mean running a property business as a company is the best financial strategy for every landlord. Setting up and running a company costs more than keeping records as an individual. 

Companies must also report their trading in a lot more detail to HMRC and Companies House. Most landlords with fewer than four homes to rent would probably find the extra recording and reporting costs that come with a company wipe out any tax savings.

Can I switch from individual to corporate property ownership?

Incorporating a property business is a contentious topic that sparks lots of debate. The framework is in place for a business to migrate from self-employment to incorporation, but the issue is if capital gains tax (CGT) is due on the transfer. Landlords who can prove renting homes is a business rather than an investment receive incorporation relief, which means they pay no CGT on any increased value of their properties when they switch businesses.

To transfer a property business into a company, you need to show you are a sole trader or in a partnership and that you have transferred the business and all its assets into a company in return for shares. 

Landlords who cannot show they run a business instead of earning money from property investment could pay a significant amount of CGT if they do not receive incorporation relief.

What to consider when incorporating

Setting up a company for a property business does not happen overnight, and the strategy is not suitable for everyone. Yes, paying corporation tax rather than income tax is an attractive option for higher rate taxpayers. Yes, reaping the benefit of all the financial interest you pay rather than a 20 per cent tax credit is appealing And yes, avoiding inheritance tax with a company has merits, too. But, when you transfer a property business into a company, the company is effectively buying the business from you. This triggers two taxes - CGT as discussed already - and stamp duty.

How much does incorporation save?

If your rental properties are worth more than £125,000, the company pays stamp duty at the standard rate plus 3 per cent based on the value of the home. The risk is HMRC will not give pre-incorporation approval to the transaction. Instead, landlords must complete the transfer and then wait for a challenge from HMRC. 

Whether incorporation works for you depends on your circumstances. If you have 30 or 40 years left in business, even small savings compounded over a long time add up to a significant amount of money. If you are approaching retirement, the figures may not work so well as you do not have time to spare. Gifting your loved ones a small amount of shares each year will help avoid inheritance tax by reducing the value of your estate on death - but do not forget that gifting a share in an asset is also giving income -  and a tax liability.

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Navigate property investment tax complexities with our detailed guide. Make informed decisions about income, capital gains, and inheritance tax.