Investment Property Accountants - WARR & CO

Investment Property Accountants

Property Investment Options

There are a number of ways in which one may undertake property investment.

Two of the main ways are: -

• Personal acquisition

• Corporate acquisition

Personal Acquisition

This is perhaps the most common way of being involved in the property business and certainly the simplest. It is in effect the default option because the moment an individual actually starts to invest into property they will be a sole trader unless they have already either set up as a Limited Company, or agreed to start the business with someone else.

Operating as a sole trader is informal. The individual has no one to answer to other than themselves and there is little by way of regulation governing the way they keep records or the format of their accounts.

There are perhaps two key disadvantages associated with being a sole trader.

The first is that of unlimited liability. Because of the informality of self-employment generally the debts of the business are the personal responsibility of the sole trader and if a creditor cannot be paid the sole trader may be declared bankrupt resulting in the loss of their home and personal belongings.

The second is that profit derived from investment property is taxable on the individual. Rental profits are added to personal income and subject to Income Tax at the prevailing rate. This may be considered a downside, as property investors are often higher rate income taxpayers.

Profit derived from purchasing and selling property, without at least attempting to rent it for a period, is treated as trading and subject to Income Tax at the individual’s highest rate of tax. Where an individual sells a property that has been let for some time, any gain is usually subject to Capital Gains Tax (CGT) at 18% after deducting the person’s annual CGT exemption (£9,600 in 2008/2009).

A partnership exists where two or more persons are trading together with a view to profit. As with sole tradership it is a form of self-employment.

Operating as a partnership is a little more formal than operating as a sole trader as there is an agreement in place between the partners. The agreement may be verbal, written or implied and will cover things such as the profit sharing arrangements, capital commitments and management of the partnership. Partners are answerable to each other but other than that, there is little or no more regulation that a partnership has to consider. The position with regulation is similar to that applying to a sole tradership in that the means by which records are kept and the format of accounts is decided by the partners.

Partners can bind the partnership to a debt and all partners are then jointly and severally liable for that debt. There is, therefore, perhaps a greater risk for a partner in a partnership than there is for a sole trader in that whilst a sole trader is personally liable only for debts that he has created, a partner is also liable for debts created by his partners.

Partners pay Income Tax and Capital Gains Tax (CGT) in the same way as sole traders but only on their own share of profits.

Corporate Acquisition

Alternatively, one might consider investing into property via a Limited Company. This may be an existing Limited Company through which a different trade is being carried out or a Special Purpose Vehicle (SPV), which is set up exclusively for the activity of property investment.

A limited company is a legal entity in its own right. It is owned by its shareholders and managed by its directors. Its directors are paid a salary to manage the business, and its shareholders may receive a dividend if the company makes a profit.

Often a business will be set up as a limited company with the same persons being both shareholders and directors.

Unlike sole tradership or partnership, there are formalities involved in operating a Limited Company. Those formalities are set out in the Companies Act 2006. Shareholders and directors have different rights and responsibilities even if they are the same persons. Each year the company must file an annual return and submit accounts to Companies House, and the format of the accounts is governed by law.

In return for the formalities that go with incorporation, the shareholders benefit from limited liability and so creditors cannot seize their personal assets if the business fails. Many see this as a significant advantage as compared to being a sole trader or partnership.

Another advantage is image. Suppliers and others tend to view a limited company as having more substance than a sole trader or partnership.

Directors of limited companies pay Income Tax and National Insurance on any salaries drawn similarly to employees. Additionally the company will pay employer’s National Insurance on salaries paid to directors and any employees. For the 2008/09 year this liability is 12.8% of the amount by which the total salary exceeds £5,435.

The company will pay Corporation Tax on its profits regardless of whether these are derived from rental streams or gains from property trading. Those profits are then available to distribute to the shareholders as dividends. The current rate of Corporation Tax for 2008/09 is 21% for companies with profits below £300,000 per annum (This will increase to 22% for 2009/2010). Where gains are crystallised, a company does not benefit from an annual exemption. However, unlike an individual, a Limited Company benefits from indexation relief.

Shareholders may be paid dividends and these come with a 10% tax credit. So, for example, a dividend of £900 is treated in the hands of the shareholder as £1,000 gross income from which 10% tax has been deducted. Basic rate taxpayers are charged 10% tax on their “gross” dividends and may use their tax credit. This means that they have no personal liability. Higher rate taxpayers pay 32.5% tax on their “gross” dividends and again can use the tax credit.

Put simply, higher rate taxpayers pay tax at a rate equivalent to 25% of the dividends they have received.

Where the directors are also the shareholders they have a lot of freedom to determine how much they should receive as salary for their work and how much should be distributed as dividends. The total tax liability on dividends is usually lower than the liability on salaries (when National Insurance is brought into the equation). So very often, in small owner managed companies, a low level of salary or none at all is paid where salary is being received from another source, and the owners are paid principally in the form of dividends. Such arrangements are perfectly acceptable so long as there are available profits from which to pay dividends and the formalities of declaring and paying a dividend have been correctly observed.

A key advantage of this option is that of control. Specifically the control that may be exercised in dictating salary and dividend levels, which in turn will influence personal tax liabilities.

There is no “one size fits all solution” to the best trading option. What is right for one property investor is wrong for another. At Warr & Co we can offer tailored advice to meet each client or potential client’s own circumstances.

Date of Article: 13th October 2008

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This domain is owned by Warr & Co Charted Accountants which is a member of the Institute of Chartered Accountants in England & Wales (ICAEW). Whilst the information detailed here is updated regularly to ensure it remains factually correct, it does not in any way constitute specific advice and no responsibility shall be accepted for any actions taken directly as a consequence of reading it. If you would like to discuss any of the points raised and / or engage our services in providing advice specific to your personal circumstances, please feel free to contact Peter Edwards on 0161 477 6789 or email us at