Income tax changes and stricter borrowing rules are leading lots of property to investors to ask if shifting a buy to let business from private ownership into a company is worth the bother.
Make no mistake, buy to let is all about crunching the numbers and understanding net yields.
But with no one-size-fits-all solution and conflicting advice even from tax professionals, now is the time to sit down and look at the options.
Surrender to yield calculations
A successful buy to let business – and by successful, most landlords would read profitable – depends on understanding the underlying finances of buying and renting out a property.
The property industry is great at quoting gross yields, but the figures are often meaningless.
The gross yield is the annual rental income expressed as a proportion of property value. The figure ignores the numbers that count – a landlord’s day-to-day business running costs and taxes on profits or gains.
Net yield is annual rent plus business costs as a proportion of property value.
Property firm Hamptons International has published research that is a great help for landlords lost in a muddle of spreadsheets and formulas hunting for the most profitable way to own and manage property.
First, look at how the tax breaks down for three different types of ownership on the assumption a landlord owns a £250,000 property with a 75% loan-to-value (LTV) mortgage:
|Company||Basic rate (20%) taxpayer||Higher rate (40%) taxpayer|
Source: Hamptons International
The table is good for a straight comparison, but not when house prices, rents and yields vary between regions.
Why net yield is the best performance measure
The next table looks at how higher rate taxpayers with 75% LTV mortgages against an average priced home see their net yields plummet when mortgage tax relief changes that first came into force in April 2016 are included in the calculations.
Higher rate taxpayers have seen their amount of mortgage interest they can offset against tax fall by half – from 40% in 2016 to 20% from 2020.
To calculate net yield, a !0% of rent cost is included to reflect repairs and expenses, like insurance.
Basic rate taxpayers see no change in their profit of £5,740 as the new mortgage interest relief rules do not affect them.
|Region||Property value||Gross yield||Net profit 2020-21||Net profit 2016-17||Change in profit from 2016-17 (£)||Change in profit from 2016-17 (%)||Net yield|
|East of England||£225,550||5.3%||£3,650||£2,956||-£694||-16%||1.6%|
|Yorkshire & Humber||£123,470||6.9%||£3,100||£2,718||-£382||-11%||2.5%|
Source: Hamptons International
What the figures reveal about buy to let
The difference between gross and net yields is stark and often comes down to the way an individual runs a buy to let business.
It’s easy for two landlords with the same houses in the same street to have different net yields because they charge a higher rent or have more control over costs.
Clearly, landlords are still making a profit, but moving property into a limited company would seem an unnecessary and false economy for many that comes with a cost that does not outweigh any tax saving.
For property investors at the lower end of the high rate tax bracket, divesting some ownership to a spouse paying basic rate tax is cheaper and just as tax effective.
The table shows the regions with the cheapest homes return the best net yields – 3.3% in the North-East, 2.6% in the North West and 2.5% in Yorkshire & Humber.
The golden rules of buy to let
Three golden rules emerged from the Hamptons International research:
- The poorest areas offer the best yields – in 2020, average yields in the 10% most affluent areas averaged 4.6%, while yields in the 10% least well-off areas averaged 8%
- An average home on an average road is better value than the worst house on the best road
- Don’t compete with first time buyers or movers – they will pay more for a home that is ready to move into but are less likely to go for a cheaper home needing a full refurbishment
The research also notes flats often show higher gross yields but extra expenses, such as ground rents and service charges can eat into net yields.
Personal v corporate ownership
The research shows switching buy to lets into a company tends to favour landlords in London and the South East because they are most likely to have mortgages.
This means they gain more from incorporating and is probably why nearly half of the 229,000 buy to let companies in England and Wales are based in the capital and home counties.
Hybrid property businesses are also becoming more common. A hybrid leaves buy to lets owned personally as they are while adding new property to a portfolio with a corporate structure.
Both business strategies come with pros and cons, says the Hamptons research.
- 100% of mortgage interest is tax deductible
- Corporation Tax is due to rise from 19% to 23% in April 2023 with taper relief for companies with profits between £50,000 and £250,000
- Corporation Tax is charged against property disposals rather than Capital Gains Tax (CGT) at 18%/28%
- Companies are more regulated than individuals and cost more to administrate ie increased accounting costs
- Stamp duty is due if transferring property into a company and CGT may be payable
- Fewer lenders will offer corporate buy to let mortgages and the rates are likely to be higher than for individual landlords
- Higher rate taxpayers may pay income tax at 32.5% on drawing dividends from a company
Find out more
Check out more about the Hamptons International data: