Recent data from HMRC 2024 Property Rental Income Statistics highlights the financial pressures on UK landlords in the private rental sector. These are primarily due to rising mortgage rates and increased operational costs, particularly insurance and service charges (on leasehold properties).

With mortgage rates surging last year, landlords are finding it harder to maintain profit margins, as more of their rental income is consumed by mortgage payments. Combined with the changes to tax relief on mortgage interest, many higher, and additional, rate taxpayers are now making losses in real cash terms.

In addition to these rising costs, landlords must navigate regulatory requirements, such as energy efficiency upgrades and tenant protection laws, which further strain their finances.

Key Challenges

1. Rising Mortgage Rates: The Bank of England's rate hikes in 2023 have led to increased monthly mortgage repayments, especially for those with variable-rate or expiring fixed-rate loans. These higher payments reduce landlords' disposable income, leaving them with less to reinvest or maintain their properties.
2. Operational Costs: Beyond mortgages, maintenance costs, insurance, and new fire and building safety regulations, such as the requirement for improved Energy Performance Certificate (EPC) ratings, have pushed expenses even higher. Inflation has only exacerbated the problem, driving up the cost of repairs, materials, and services.
3. Regulatory Burdens: Compliance with changing laws, including stricter tenant protection measures, and the recently approved "no-fault" evictions, adds complexity to managing properties. Many landlords also face pressure to meet eco-friendly standards, requiring costly renovations that affect profitability.

Limited Company Ownership as a Solution

In response to these financial challenges, some landlords are choosing to incorporate their residential property portfolios into limited companies. This can offer several tax benefits, including lower corporation tax rates (19% or 25%), compared to personal income tax (up to 45%) and capital gains tax (CGT) up to 24%. If there is any debt against the properties, the interest is fully relievable unlike with personal ownership, where the relief is capped at 20%. Indeed, recent research from the estate agent, Hamptons, suggests that purchases of residential property through limited companies is on the increase.

Although subsequent distributions from the company will usually be subject to income tax (in the hands of the recipient), structured correctly, the effective rate should be lower than if the property was held directly by the individual. If the transfer to the company is treated as a loan (based on the value of the property), then future distributions can be taken tax-free as they are deemed a repayment of that debt.

The initial transfer of property into a company will usually give rise to both CGT and stamp duty land tax (SDLT), so this option may not be appropriate for everyone. But if the individual has any capital losses brought forward, or is transferring more than five residential properties, these charges can be mitigated. In certain scenarios, the CGT charge can be deferred through the availability of incorporation relief. And if the letting business is currently run as a formal partnership, it may also be possible to circumvent SDLT.

While incorporation offers significant tax advantages, landlords need to consider the challenges of operating through a limited company. There are higher administrative and legal responsibilities, and obtaining mortgages through a company typically comes with slightly higher interest rates and fewer lender options. Still, the long-term tax savings and ability to reinvest profits can outweigh these drawbacks for many landlords.

Involving the family

For married couples and those in civil partnerships, it is possible to alter the way in which property is owned to maximise tax efficiency, making use of two lots of personal allowances and basic rate bands. When properties are sold, the owners should also benefit from two lots of CGT annual exemptions. If the property is already in joint names, any change in ownership percentages shouldn't give rise to an SDLT liability (provided both parties still hold a stake in the property, no matter how small). But if a transfer is from sole to joint names, this may trigger an unwelcome SDLT charge. As inter-spousal transfers take place at no gain, no loss, these alterations should never give rise to a CGT charge.

For those with children, transferring properties sooner rather than later will help to mitigate future exposure to inheritance tax (IHT). And can also reduce the overall income tax burden of the property if the recipient is a non, or basic rate, taxpayer. As with a company, the initial transfer will be subject to CGT. Though this can be mitigated through the availability of capital losses and two lots of annual exemptions and basic rate bands. But unlike the corporate scenario, SDLT will only be chargeable if the donor receives consideration for the transfer.

A combination of the two

For those looking to retain an interest in the property, a family investment company may be a more appropriate solution. Broadly speaking, this type of structure would allow the owners to benefit from a corporate structure while also being effective for inheritance tax purposes. Structured correctly, it would allow younger family members to benefit from the future growth in the property but would still allow the owners to receive a tax efficient income.

Selling up

Given the current inflationary environment, some landlords may simply prefer to sell up and exit the property business, particularly if the above options are not feasible. For properties that have grown in value significantly over the years, this will give rise to a CGT liability. But unlike with incorporation, or a gift to a family member, the individual will have cash proceeds to cover the tax.

There was much talk before the Budget that CGT rates would increase significantly, particularly for residential property. But as these were left untouched, selling up still appears to be a sensible option for many. If the net proceeds are reinvested sensibly in another asset, it may also be possible to generate a better return each year, together with the potential for capital growth.

Conclusion

For those willing to navigate the complexities, owning property through a limited company offers potential tax relief and financial flexibility. Balancing the benefits and challenges will be key for landlords aiming to stay profitable in a changing market. For others, now may be the time to sell up and look for other opportunities.

If you are considering what to do with your property (ies), or would like to discuss any of these options in more detail, please contact us for a free, initial consultation.

Where appropriate, we can also introduce you to one of our trusted third parties for assistance with refinancing arrangements or other investment opportunities.

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