CGT LANDLORD SPECIAL
A tax giveaway for landlords?
Landlords are set to be one of the main beneficiaries from the proposed tax changes signalled by the Chancellors Pre-budget Statement last week. This Statement which outlines what changes are to be made for the tax year 08-09 or effectively the tax regime that is to come into force on the 6th April 08. How much is it a give away, are landlords better to sell now under the current tax regime or should they wait? Property Hawk sets out to investigate.
The current regime
The current system of Capital Gains Tax (CGT) was actually put in place by Gordon Brown in April 1998 when he introduced a system of taper relief to replace the previous system of indexation. The whole idea behind taper relief was that it encouraged businesses and investors to hold their assets for the long term and discourage short-term speculation. The result was a system where the amount a tax paid reduced the longer the landlord held their buy-to-let investment property for up to a maximum relief being given after 10 years of holding their residential investment.
When does CGT apply?
Capital gains tax is a tax landlord’s only pay on disposal of their buy-to-let investment property. It is treated as a top slice of taxable income and therefore the rate that a landlord will pay will depend on what income they have earned in the year of disposal. In calculating a landlord’s potential Capital Gains Tax (CGT) tax liability a landlord will have to apply the following concepts to their Capital Gains Tax (CGT) calculation.
1. Establish the base cost of their buy-to-let investment (effectively cost of acquisition)
2. Establish the size of the gain by taking base cost from disposal value
3. Establish if buy-to-let investment held as a non-business or as a business asset (most will be non-business, whilst holiday rentals are classed as a business asset)
4. If the buy-to-let investment property is held as an individual not by a company the landlord can use their annual exemption 2006/2007 £8800 to reduce the amount of the chargeable gain
5. For properties bought before April 6 1998 the gain is subject to indexation
6. Properties bought on or after April 6 1998 the gain is subject to taper relief
For full details see the Landlords Bible
Effective rate of Capital Gains Tax (CGT)
For most landlords the effective rate of Capital Gains Tax (CGT) that a landlord will pay depends on their rate of income tax. For a landlord who is a basic rate tax payer the effective Capital Gains Tax (CGT) rate could reduce to 12% as the percentage of the gain chargeable reduces to 60% after 10 years and this is then charged at 20%. For landlords who are top rate tax payers the effective rate is double as they pay 40% tax.
The new regime
The new Chancellor Alistair Darling is planning to sweep away the old systems of indexation and taper relief carefully put in place by the previous Chancellor and replace the systems of indexation and taper relief with a single flat rate of 18%.
Property Hawk verdict
On balance the news for landlords is good. The new flat rate Capital Gains Tax (CGT) will apply to a landlord immediately and means that for a high rate tax payer they will be paying 6% less than they would have done after 10 years under the previous system of taper relief. For basic rate tax payers things are less clear cut. Under the previous system a basic rate tax payer would have had to have held their buy-to-let investment property for 4 years before benefiting from a rate as low as 18%. However, this would have eventually reduced to 12% after 10 years or 6% below the rate that will come in on 6th April 2008.
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A couple of beneficial points for landlords are that the new system is much simpler to understand and should make disposal decisions and calculations much easier for landlords.
It also makes it far more attractive for landlords to trade their buy-to-let investments buying and potentially renovating a property, holding for a couple of years before then selling their buy-to-let investments on.
However, this may not be so much of a tax gift to landlords as it first appears. For a start, the anticipated slow down in the UK housing market may mean that the opportunities for buying a property and doing it up to rent and then dispose may not be as prevalent as they have been over the last 10 years of the housing boom. Also landlords should be aware that if they are doing this regularly the tax authorities may consider that the landlord is actually engaging in a trade and tax any profit as income anyway.
The reality is for most landlords buying a residential investment property is seen as a long term investment. ARLA the Association of Residential Letting Agents latest quarterly survey (Sept 07) of landlords showed that 66% of landlords questioned intended to keep their residential investment properties for more than 10 years. These landlords would therefore have benefited from the maximum taper relief available anyway.
The proposed tax changes appear to be a classic case of smoke and mirrors where tax for some landlords i.e. high rate tax payers looks to have come down whilst those for lower rate tax risers potentially goes up.
Should landlords sell?
This potential change in the tax law has thrown up an interesting conundrum for some landlords over what to do over their buy-to-let investments.
Previously the tax system strongly encouraged them to hold their properties for the long-term to maximise their taper relief. Now, for a lower rate tax payer who has owned their property for 10 years or more a quick disposal before the new regime would save them potentially a considerable sum.
Equally for high rate tax payers who were thinking of a sale, holding out until the new tax regime is in place could also save them a sizeable amount of money.
Therefore, all this has to be weighed by a landlord against their wider and long term financial plans and aspirations. If the housing market does weaken considerably by next year selling at a time of low housing demand may not be the best time to exit the market even where a tax saving could be potentially made.