Capital Gains Tax (CGT)
What Capital Gains Tax will landlords be expected to pay?
Landlords will be liable for buy to let Capital Gains Tax (CGT) when they sell a rental property at a ‘profit’. As of April 2008 the Capital Gains Tax was a flat rate of 18%, but from June 23 2010 higher rate tax payers have been expected to pay CGT at 28%.
The profit is obviously the difference between what a landlord bought a buy to let property for and the selling price. The good news is that even if a landlord has made a profit, they are still not automatically liable to pay buy to let Capital Gains Tax( CGT ). This is because there are a number of exemptions and allowances from Capital Gains Tax for landlords.
First of all, before deducting allowances a landlord will need to establish the Base Cost of the property. To establish the Base Cost additional costs need to be added to the initial acquisition costs (or where the property was acquired prior to 31st March 1982 the market value on that date which ever is the higher – a process known as rebasing).
These base costs are:
- Incidental costs of acquisition (e.g. legal fees, stamp duty, etc).
- Enhancement expenditure (e.g. the cost of building an extension to a property).
- Expenditure incurred in establishing, preserving or defending title to, or rights over, the asset (e.g. legal fees incurred as a result of a boundary dispute).
The initial capital gain is then calculated by taking the Base Cost from the sales price.
An example of a landlords capital gains tax liablity
Tom the landlord bought his bungalow in July 1995 for £50,000. He paid stamp duty of £500, legal fees of £350, mortgage broker’s fee of £250 and removal costs of £535.
The place was in a bad state of repair as an elderly couple had lived in it previously. Therefore, it needed complete modernisation.
These works cost as follows:
1. redecoration £2000
2. new kitchen £5000
3. new bathroom £3000
Not content with this upgrading work for his tenants, Tom’s next project was the erection of a shiny new conservatory to house his tenant’s collection of carnivorous houseplants. This cost him an additional £15,000 (comprising of £14,000 construction cost and £1000 design and building regs fees).
However, in his enthusiasm to secure the maximum floor space. Tom the landlord built very close to his neighbours Jerry’s boundary. Jerry was a little jealous of Tom’s magnificent erection and aggrieved that it had crossed onto his boundary. He instructed his solicitor to send a letter threatening legal action to have it removed. Tom the landlord contested this and after Tom had spent £500 on legal fees, Jerry dropped his action.
In 1999 Tom the landlord suffered damage to his weather vein of £500. He secretly suspected that it was malicious damage by Jerry but was unable to proof anything. When Tom the landlord tried to claim for damage to his weather vein, the insurance company refused to pay out, stating it was storm damage and classed as an act of god not covered by his policy.
In 2000 fed up with Jerry’s constant agitation. Tom the landlord sold his bungalow for £125,000. How much was Tom’s Base Cost for Capital Gains Tax ( CGT ) purposes?
|Incidental cost of acquisition||£1000 (legal fees, stamp duty and mortgage broker’s fee). The removal costs were a personal cost and not part of the capital cost of the property.|
|Refurbishment works||£10,000 classed as enhancement works & therefore a capital cost|
|Building of conservatory||£15,000 also classed as enhancement works & therefore a capital cost|
|Legal fees defending title to property||£500 contesting boundary with Jerry|
|TOTAL BASE COST||£76,500|
Annual exemptions and personal allowance on CGT
The personal allowance allows each individual landlord to make a certain amount in capital gains each year without having to pay Capital Gains Tax ( CGT ). These exemption changes every year. In the tax year 2020-21 it was £12,300. Unfortunately, this exemption only applies in the year of disposal of the asset. Unused balances from previous years cannot be carried forward.
In addition to the annual buy to let Capital Gains Tax ( CGT ) allowance for landlords there are a number of expenses and deductions that can also be taken into account to reduce a landlords potential liability. Some of these are used to generate the Base Cost as previously mentioned. Expenses that are deductible are:
- the costs of acquisition such as solicitors fees, mortgage brokers fees, etc
- money spent on the property, including renovation and improvement costs
- the cost of disposal such as estate agents, solicitors, advertising. Remember not to get caught double counting the costs you may have already included under Schedule A as a repair.
Occasionally, the disposal of the investment property by a landlord may not be through the open market but to a connected person e.g. to a relative or a family company. In this case HMRC makes the automatic assumption that the bargain is not at ‘arms length’. In this case a “market value” is substituted for the actual sale proceeds if the two amounts differ. Of course one thing for landlords to note is that valuation of property to many is an art not a science and as a result there is an acceptance that valuations by different agents can vary by as much as 10%. If a landlord is planning a transfer, then make sure that they evidence the ‘market value’.
Therefore, it would be best for a landlord to obtain a number of written estate agents valuations. Obviously you then select the valuation that most closely reflects the ‘market value’ at which the transfer took place.
Generally, there is no Capital Gains Tax ( CGT ) payable by a landlord where there are transfers between husband and wife and also where property is transferred to a charity.
Private Residence Relief (PRR) or main residence exemption
As I’m sure most landlords are aware, where a property is occupied as a person’s main residence they are not liable for Capital Gains Tax ( CGT ) on disposal. This tax exemption is also known as Private Residence Relief or PRR. That’s why you don’t have to pay Capiatl Gains Tax ( CGT ) when you sell your home. There are, as in all cases in tax law, complications. For instance when individuals are required to live away from their property in ‘job related’ accommodation. In these cases it is possible for them to nominate a property they own as their main residence, despite living elsewhere.
Examples of where this might occur are for a:
- pub landlord
- care worker
- agricultural worker
Frequently the case arises where a landlord buys a home and then has to move because of work, etc. In this situation they decide to rent out their house and therefore on disposal will not have lived in the property for their entire time of ownership. How does this affect a landlords exemption status?
For a start, where a property was rented out prior to 31 March 1982, this period of non-qualifying use is ignored. The tax regulations allows for the proportion of the capital gain to be exempt where the conditions pertaining to primary residence are met. In other words the following equation applies where the period of qualifying use being that period where the property qualifies as the person’s private residence or benefits from one of more of the stated exemptions.
Period of qualifying use/total period of ownership * (multiply) indexed gain
Finally, if you have lived at any stage in the property as your main residence, then from the 6th April 2020 the last 9 months of ownership qualify for exemption from Capital Gains Tax ( CGT ). This even applies when the period of occupation occurred prior to 31 March 1982. The one exception to this is where the resident of the property is moving into care in which case the excemption from Capital Gains Tax (CGT) remains at 3 years.
The implications of this are that if a landlord has a property with a large potential capital gain, derived during the last 9 months. Where you have not lived in the property before, the landlord may want to consider moving into it as your main residence to reduce your capital gains tax ( CGT ) liability. This is no longer an attractive way of mitigating a CGT tax liability as a result of the removal of much of the benefits of Lettings Relief in April 2020.
Other exemptions of Private Residence Relief (PRR) that may apply are in circumstances where individuals are required to work away from home. If you think this may apply to you I would obtain a specialist tax text or consult a professional tax adviser as the matter can get very complex.
Alternatively try the practitioner’s zone on the HMRC website. For further details on tax matters have a look at www.propertyhawk.co.uk for advice and the latest developments.
What is the rate of Capital Gains Tax ( CGT )?
Any net capital gains are worked out after allowing for deductions and allowances. From April 2008 the rate charged on any property disposal by a landlord is a flat 18% rate. Prior to that, the tax was added to your income tax liability. The rate charged therefore corresponded to what would be payable if the sum was derived as income.
Some capital gains tax saving tips for landlords
The truth is that the main tax saving trick for landlords is to move into their investment property prior to sale. If the property is your main residence holding the property is the Private Residence Relief (PRR). For details see above. The other trick was up until recently was just sell up and move abroad. This was because landlords who were non-resident were exempt from Capital Gains Tax (CGT). This changed from 6th April 2015. The new regime relating to how capital gains tax is applied to non UK residents is explained in this HM Revenue & Customs publication.
In essence the gains are apportioned from April 2015 but with PRR including final period relief being available.
For more details on saving on capital gains tax on your rental properties have a look at the Property Hawk Taxation Bookshop and the Property Capital Gains Tax guide which covers the following:
How to distinguish between improvements and repairs and obtain the best tax outcome.
Transferring assets to a spouse with short life expectancy – possibly the simplest and most powerful way to completely avoid capital gains tax.
How to completely avoid/reduce capital gains tax if you emigrate.
The enormous tax benefits of furnished holiday lets, including rollover relief and 10% capital gains tax.
The new Seed Enterprise Investment Scheme (SEIS), offering a 50% income tax refund and CGT exemption.
The new Entrepreneurs Relief rules – How to pay tax at 10% and save up to £1.8 million.
How to convert heavily taxed income into leniently taxed capital gains.
The ins and outs of Principal Private Residence Exemption….including how the exemption can be used to avoid capital gains tax altogether.
Using your children to help you avoid capital gains tax completely.
How trusts can be used to safeguard children’s properties.
Main residence elections – How to enjoy a tax-free second home
…plus some special tricks to obtain extra tax savings on multiple properties.
How unmarried couples can have two tax-free main residences… plus the traps to avoid.
How to develop part of your home and avoid CGT.
The tricks to avoid being classified as a property trader and taxed at 42% or 47%.
The relative merit of using a company to invest in property and reduce your CGT liabilities.
Reducing your taxable income and paying CGT at 18% instead of 28%.
Learn how your spouse or partner can save you £17,453 per year in capital gains tax.
Capital Gains Tax deferment
The Chancellor in his efforts to encourage investment in small businesses has created a mechanism to defer paying capital gains tax. Companies can now be set up under the umbrella Enterprise Initiative Scheme as qualifying investments. Investments in these companies allow investors to defer paying Capital Gains Tax ( CGT ) and basic rate income tax.
How does it work?
Let’s start with the example where a property is sold realising a capital gain of £100,000 after allowances and deductions. The owner, as a top rate income tax payer would be liable to pay £40,000 Capital Gains Tax ( CGT ). However, they decide to invest the receipts of £100,000 into a EIS company. Following the approval of the investment by the Inland Revenue the individual receives back the £40,000 back in tax. This means that for this £60,000 of funds the investor receives £100,000 worth of shares.
It gets better! It’s also possible where you do not own the company to benefit from income tax relief at the basic rate of 20%. In this situation you would therefore receive £100,000 of shares for a £40,000 net investment. The bad news is that if you sell within 3 years the income tax relief is withdrawn & also you will not benefit from the exemption from capital gains in the share price made during that time.
Should you sell the shares at any stage the original Capital Gains Tax ( CGT ) which was deferred is ‘crystallised’ and the tax will have to repaid. However, as long as you retain the investments or roll them over into another qualify investment the liability remains deferred. A word of warning through. Saving tax by putting money into a good investment can be an efficient way of investing money. However, putting your funds into a poor investment that goes bust will just means that you end up loosing your money as well as the ‘taxmans’!