Can I Set Up A Company To Buy Properties?

Can I Set Up A Company To Buy Properties?

Are you a property owner? Or perhaps a business owner? Do you often hear stories about individuals setting up companies to purchase properties? Regardless of whether you have a house or a limited company to your name, it is essential that you understand the pros and cons of founding an investment holding company to buy properties before following in the footsteps of those who have done so.

What is an Investment Holding Company?

It is a company that has investments under its name – including property, shares and bonds. The company obtains income from these investments in the long run, which come in the form of capital gains, rental income as well as dividends paid on stocks.

Individuals who set up an investment holding company to purchase a second property will be subject to the Total Debt Servicing Ratio (TDSR). TDSR restricts the amount an individual can borrow to finance his property loan to 60% of his gross monthly income, taking into account the individual’s other financial commitments. Read our article on ‘What is TDSR? MSR?’ to find out more.

Furthermore, for residential properties, one is eligible for a 15% Loan-to-Value (LTV) and liable for an Additional Buyer’s Stamp Duty (ABSD) of 20%. For commercial or industrial properties, one is eligible for up to 90% LTV and no ABSD is payable.

The Pros of Setting Up an Investment Holding Company

Investors set up investment holding companies for various reasons – the primary objective being to economize on costs incurred.

Homeowners often purchase a second property to serve as an investment. Should the value of the property increase substantially over the years, investors can reap significant profits from the sale of the property. Subletting the house can also bring in a steady flow of monthly rental income.

Of course, with income, there will be taxes. This is where an investment holding company comes in. Having the property under a company will mean that the profits gained will be subject to corporate tax instead of an individual’s income tax. Given that corporate tax rates are approximately half of income tax rates, the amount of tax levied will be reduced to a great extent.

Furthermore, with the new rules with regard to mortgage tax relief taking effect from April 2020, property owners will no longer be able to subtract mortgage interest costs from their taxable profits if the property is under the name of an individual. They are only entitled to a basic rate deduction of the mortgage interest costs. On the other hand, this ruling does not apply to company-owned properties.

The Cons of Setting Up an Investment Holding Company

A major downside of setting up an investment holding company would be having to face the obstacles hindering a limited company from obtaining a loan. Most of the banks and financial institutions are unwilling to grant limited companies a loan. If they do accede to the request, they will more often than not require a personal guarantee. Otherwise, they might either offer a loan that comes with higher interest rates or a lower loan-to-value (LTV) ratio.

Furthermore, as a limited company, the company’s financial statements have to be filed and the company accounts audited. This means that you will be forking out additional accountancy costs and perhaps also be drowning in a sea of paperwork at the same time.

Factors to Consider

  • Tax Rates

With the implementation of the new rules with regard to mortgage tax relief, if you pay taxes at the basic rate, the cost savings from buying a second property through an investment holding company may not be a sizeable amount. Here are the figures:

 

Scenario 1 (applicable for company-owned properties w.e.f. April 2020)

Monthly Rental Income$6,000
Mortgage Interest Costs$3,000
Other Associated Costs$500
=Profits$2,500

 

  1. If you are paying a basic tax rate of 20%, you will pay 0.2($2,500)= $500 in taxes.
  2. If you are paying a higher tax rate of 40%, you will pay 0.4($2,500)= $1,000 in taxes.

Scenario 2 (applicable for individually-owned properties w.e.f. April 2020)

Monthly Rental Income$6,000
Mortgage Interest Costs$3,000
Other Associated Costs$500
=Profits$5,500

 

As mentioned above, for individually-owned properties, you are entitled to a basic rate deduction (20%) of the mortgage interest costs, which would be 0.2($3,000)= $600.

  1. If you are paying a basic tax rate of 20%, you will pay 0.2($5,500)-$600 = $500 in taxes.
  2. If you are paying a higher tax rate of 40%, you will pay 0.4($5,500)-$600 = $1,600 in taxes.

Comparing Scenario 1A with Scenario 2A, it is evident that individuals who are paying the basic tax rate do not enjoy a large amount of cost savings. In fact, both are paying the same amount. However, comparing Scenario 1B with Scenario 2B, purchasing the property through a company instead of purchasing it as an individual can save you $600 in taxes.

  • Purpose of Investment

If you have the intention of leaving the property as a family asset to your descendants upon your demise, purchasing the property under a company’s name may be favourable. This is because you get to earn inheritance tax savings. How does this work? Firstly, your children have to become the shareholders of your company. Subsequently, the sale proceeds of the inherited property can be distributed amongst the shareholders. Because this sum of money is subject to tax rates that are lower than that of inheritance tax rates, savings are generated.

Conclusion

Now that we have come to the end of this article, are you able to better comprehend the rationale behind the decision to set up an investment holding company? It is important to note that whilst its benefits are bountiful, it is not a one-size-fits-all strategy that works for everyone. You will have to factor in the gains and losses involved before delving into this scheme. Speak to our mortgage specialists to discuss your options today.