Buying property to trade or as an investment
If you are buying property to fix up and sell straight away to make a profit, then this is trading. It means that selling property is your income and buying property is expenditure. In comparison, if you are buying property to rent out and sell at a later date then this is an investment. Investments are assets and the eventual sale of your property is a capital (or chargeable) gain rather than trading profit.
This article focuses on buy to let investments.
The difference between capital expenditure and revenue expenditure
The difference is whether the purchase will be used over the long or short term. Capital expenditures are large purchases of assets which will generate revenue over a longer period of time and are hopefully sold later for a profit (capital appreciation).
Capital expenditure for accounting purposes is included on a balance sheet as an asset and not an expense in the profit and loss. This means it does not reduce a business’s trading profit but will be deducted from the sale price to work out the capital gain.
What expenses are revenue expenses and which are capital expenditure?
Revenue expenses are those which include the day to day running costs of the property. For example, repairs to the property, maintenance, letting agent fees and mortgage interest (see below for more information on this).
Capital expenditure is expenditure which is used in the business over a longer period of time. For example, adding to the property (such as an extension), upgrade, improve the property or the purchase of finishings and equipment used within the property.
As an example, let’s say your tenant reports a leak in the kitchen ceiling. If you repair the leak and patch up the ceiling this is a revenue expense which you would claim. However, if the leak was serious and you had to replace the kitchen then this would be capital expenditure and the cost would be offset against the sale price of the property.
The same is true for carrying out work on a property before renting it. If work is being completed to improve the property to bring it to an acceptable state for renting, then this would be capital expenditure.
In addition, the costs associated with purchasing a property are usually capital expenses. For example, legal fees incurred to purchase the property would be capital expenditure but legal fees for renewing a tenant’s lease for a year or less would be revenue expenditure.
Buying property as an individual or through a limited company
Deciding whether to buy your investment properties in your own name or through a limited company is important. There are pros and cons which should be considered with each method.
From April 2020 individuals will no longer be able to deduct mortgage interest costs from taxable profit. This change does not affect limited companies which are still able to claim 100% of the mortgage interest. It has led to a lot of investors choosing limited companies as a vehicle to invest in properties. However, there are other factors to consider:
Pros of using a limited company
If the properties are sold for a profit then the gain is taxable at the corporation tax rate of 19% rather than the higher rate thresholds for individuals at 40% or higher (depending on the profit amount and tax bracket of the individual). However, if the owners want to extract the money from the company rather than reinvesting it then there will likely be additional tax on the dividends taken (payments to owners from company profits).
As mentioned above, mortgage interest is still claimable for companies
Cons of using a limited company
Getting a mortgage through a limited company can be harder and more expensive than as an individual due to more paperwork and fewer options available from lenders.This is improving over time but it still remains a factor to consider
Running a limited company involves a little more admin and slightly more in fees; accountancy fees for example
When a property is sold for a profit, the company pays tax on all of the profit whereas individuals get an Annual Exempt Amount which means tax is only paid on income earned over a threshold of £12,000 (tax year 2019-20)
Can I transfer my property to a limited company?
A misconception of transferring a property from a person to a company is that it can just be ‘put in the company’s name’. A limited company is a separate legal entity and so transferring property to a company is the same process as selling it, i.e. it must be legally sold. This gives rise to potential additional costs including:
Capital gains tax for the individual (if a profit is made on the sale/transfer)
Early redemption charges on existing mortgages and e-mortgage costs.
Legal fees for handling the sale
Properties must be sold at the market value meaning artificially lowering the value to save some of the above taxes and fees is not possible.