This article appeared in the Yorkshire Post on Wednesday 23rd November 2005. 

G&E Taxing Times - Should you use a company to invest in property?

Duncan Meredith G&E Tax Consultant

You may be an experienced property investor or you may be just starting out. Duncan Meredith, tax consultant in Garbutt & Elliott's Property Services Group, looks at the use of companies in property investment situations.

In my previous article, I talked about the distinction between property dealing and property investment. It is sometimes difficult to decide what activity you are carrying on. The distinction is vitally important from a tax-planning viewpoint.

Supposing you are an investor, should you hold the properties personally or would it be good idea to own a company that invests direct in properties? That is a difficult question, which can only be properly answered when your precise circumstances are considered. There are some pointers, however.

The main benefit derived from using a company would be the lower tax rates on rental income. If the company then paid out its profits as a dividend, the outcome could be very satisfactory, compared with up-front taxation on rents received direct. The timing of income payments to you can be controlled, maximising their efficiency in tax terms.

Over the long run, the benefit of additional retained profits could be seen in a higher capital value of your property portfolio, as the extra cash is used to pay off loans and invest in more premises. I have seen an example where the net asset value of a portfolio was almost doubled, in this way.

This advantage can extend to the profits on sales of investments. Companies pay the same tax rates on both income and gains ('profits'), so the benefit of tax savings and reinvestment can be boosted, even when turning over some of the properties.

Companies do cost more to run than the equivalent unincorporated business. Over time, the tax savings will outweigh these additional costs but not necessarily in the short-term.

However, the treatment of capital gains in the hands of individuals greatly differs from that for companies. This can mean that it can be advantageous to hold properties personally, particularly if investing for growth in the commercial sector, when tax rates on sales could be as low as 5/10%. Careful planning can virtually eliminate small gains and the impact of even very large gains can be eased.

It is possible to transfer an existing property investment business (usually more than one property) to a company tax-free (but with a charge to stamp duty land tax to consider). Clearly, this could lead to annual tax savings on income and gains but also might help a situation where properties are to be sold at a substantial gain. The gain could be deferred, effectively indefinitely if the company is continued with. The downside is that the capital would then be tied into the company, which would not help to pay the school fees, for example (it would be expensive to extract cash from the company in those circumstances).

A general point worth making is that the benefit of a lower rate of tax in a company would be wasted if the profit were paid straight out to you. The combined tax rates would leave you worse off than if you held the property yourself and paid the capital gains tax direct.

Eventually, growth in any investment property portfolio will cause a capital tax problem: either capital gains on sale or inheritance tax on your estate. This would affect you whether you hold your properties direct or in a company. There is scope for dealing with this.

Typical would be the use of trusts, either transferring existing properties or as a vehicle for new acquisitions. Alternatively, using the flexibility of a company to pass shares onto the next generation. As always, a balance must be struck between tax saving and keeping enough for your own needs, particularly when relying on the income stream.

Garbutt & Elliott are Chartered Accountants and tax advisers with offices in Leeds (telephone 0113 273 9600) and York (01904 464100). Duncan Meredith can be contacted at the York office, or by email to dmeredith@garbutt-elliott.co.uk.