Residential vs Commercial Lettings: A Tax Comparison for Would-Be Landlords

Would-be landlords face a variety of decisions when starting their property investment journey. One of the most significant decisions is whether to operate as an unincorporated property business or a property company, as well as whether to invest in residential or commercial property. The tax implications vary between these options, and understanding the pros and cons of residential and commercial lettings can help landlords make the most tax-efficient choices.

Key Tax Considerations

Before diving into the specifics of residential and commercial property lettings, it’s important to note a few general points:

• The tax treatment depends on whether the landlord is operating as a sole trader or through a company.
• As of 6 April 2025, the furnished holiday lettings (FHL) regime will align with the tax treatment of other residential lettings, meaning it will no longer enjoy the beneficial tax reliefs it previously did. These changes are not covered in this article but are important for landlords currently operating FHLs.

Relief for Interest and Finance Costs

One of the most notable tax differences between residential and commercial property lettings involves the treatment of interest and finance costs.

Unincorporated Landlords (Sole Traders)

Residential Property: Unincorporated landlords cannot deduct interest and finance costs from taxable rental profits when renting out residential properties. Instead, they receive a tax reduction equal to 20% of the lower of:

• Interest and finance costs
• Property business profits
• Adjusted net income
  This means that landlords will only receive a tax benefit at a flat rate of 20% for residential property.

The unused interest and finance costs can be carried forward and offset against profits in future years, but this can create cash flow challenges for landlords if the costs cannot be fully relieved in the year they are incurred.

Commercial Property: On the other hand, unincorporated landlords can deduct interest and finance costs in full from taxable profits for commercial properties. This is a significant advantage as it allows the landlord to receive tax relief at their marginal income tax rate, which could be as high as 45% for higher-rate taxpayers. If the interest costs create a loss, this can be carried forward and offset against future profits of the same property rental business.

Landlords Operating Through a Company

• Residential and Commercial Property: If the property rental business is run through a company, interest and finance costs for both residential and commercial properties are fully deductible. This provides more flexibility and tax relief at the corporation tax rate, which ranges from 19% to 25%, depending on the company’s profits.

Capital Gains Tax (CGT)

Capital gains arising from the sale of both residential and commercial properties are now taxed at the same rate for unincorporated landlords. However, there are differences in when the tax is paid and reported.

• Residential Property: CGT on residential property gains must be reported and paid within 60 days of the sale. This tight deadline can put pressure on landlords’ cash flow, as they must arrange payment quickly after the sale.
• Commercial Property: By contrast, CGT on commercial property sales is not due until 31 January following the end of the tax year in which the sale occurred. This provides a cash flow advantage, as landlords have more time to plan and manage their tax payment.
• Corporate Landlords: In the case of companies, CGT on the disposal of both residential and commercial properties is charged to corporation tax and payable on the due date, which is nine months and one day after the end of the accounting period.

Stamp Duty Land Tax (SDLT)

Stamp Duty Land Tax (SDLT) is payable on the purchase of property in England and Northern Ireland. The rates vary depending on whether the property is residential or non-residential, with non-residential (including mixed-use) properties benefiting from lower rates.

• Residential Property SDLT: For residential property, the SDLT rates for an individual are as follows:
• First Property:
• Up to £125,000: 0%
• £125,001 to £250,000: 2%
• £250,001 to £925,000: 5%
• £925,001 to £1.5m: 10%
• Above £1.5m: 12%

 

Second and Subsequent Properties: A 5% surcharge applies on properties costing £40,000 or more.

• Commercial Property SDLT: The rates for non-residential property are:
• Up to £150,000: 0%
• £150,001 to £250,000: 2%
• Above £250,000: 5%

For example, on a £500,000 commercial property, the SDLT payable would be £14,500, whereas for a residential property, it would be £40,500 for a second property.

Conclusion: Opting for commercial properties could result in substantial savings in SDLT, especially for those purchasing a second residential property.

Annual Tax on Enveloped Dwellings (ATED)

Companies that own residential properties worth £500,000 or more may be subject to the Annual Tax on Enveloped Dwellings (ATED). This tax does not apply to commercial properties, making them a more attractive investment for companies looking to avoid this tax.

For 2025/26, the ATED charge ranges from £4,450 for properties valued between £500,000 and £1m to £292,350 for properties valued at £20m or more.

Capital Allowances

• Residential Property: Capital allowances are not available for residential property, whether held by an individual or a company.
• Commercial Property: Landlords can claim capital allowances on commercial properties. These include:
• Plant and machinery: Full relief can be claimed via the Annual Investment Allowance (AIA), which allows landlords to deduct up to £1m worth of capital expenditures in the year of purchase.
• Structures and Buildings Allowance (SBA): For new commercial buildings, landlords can claim an annual deduction over 33 years for construction costs.

For corporate landlords, full expensing is also available, making commercial property investment even more appealing if the AIA limit is reached.

Summary: Residential vs Commercial Lettings

For landlords choosing between residential and commercial properties, commercial lettings provide significant tax advantages, particularly regarding interest relief, capital allowances, SDLT savings, and the absence of ATED. Residential lettings, while generally more straightforward, are subject to stricter tax rules, particularly around interest relief and CGT reporting.

Conclusion

When deciding between residential and commercial property investment, landlords must weigh the benefits of commercial properties in terms of tax relief and cash flow against the simplicity of managing residential lettings. For those operating through a company, commercial properties offer the best overall tax efficiencies. However, for those not running a property business through a company, residential properties still offer an avenue for investment, albeit with more limitations in tax relief.

Merranti Accounting can help guide you through the complexities of property investment and tax planning. Whether you are a sole trader or operating through a company, we can provide advice tailored to your individual circumstances. Contact us today for personalized tax advice to make the most of your property investment.