HMRC target landlords Capital Gains Tax (CGT)
HMRC’s Capital Gains Tax Review indicates that the Government may be more rigorous than ever in coaxing Capital Gains Tax (CGT) cash out of landlords. We already know that HMRC systematically uses Land Registry details to ensure that they collect all the landlords Capital Gains Tax (CGT) due to them. The Government has recently re-doubled their efforts of ensuring landlords pay the property income tax due to them by updating their guidance on their Let Property Campaign which encourages landlords to pay the tax due who may have mistakenly not disclosed their tax liabilities by mistake. Failure to pay tax on a buy-to-let rental property may result in a Tax Investigation.
Property Hawk has explained previously how landlords can save large amounts of income tax by employing clever avoidance techniques.
Capital Gains Tax (CGT) Report lines up landlords
The Government has just published a new report called the Capital Gains Tax Review – Simplyfying By Design released on the 11th November. It lines up landlords for big hikes in Capital Gains Tax charges by arguing that CGT rates should be aligned to income tax rates. The Office for Tax Simplification (OTS) makes a convenient case and a ‘not surprising’ one given the departments name that the same rates for capital gains and income tax would simplify the tax system and they maintain, reduce the current distortion in the system which results they claim in higher income rate tax payers such as some landlords and owers of holiday lets taking advantage of ‘tax loopholes’.
Landlord ‘Tax Loopholes’
These tax loopholes are nothing more than careful tax planning that is entirely legal and sensible by landlords and their tax advisors. Currently any landlord looking at disposing of a rental property benefits from the standard rate of CGT exemption which stands at £12,300 pa. There are other expenses that they can offset against their CGT bill before coming to the base costs in the tax computations.
Recent research has shown that the averge landlord that sold a buy-to-let in England or Wales made a gross capital gain of £69,000 well above any allowances that are likely to be available. This means that a landlord paying a basic rate of tax would be liable to pay 18% and those on the higher rate of income tax would have to pay 28% on the gain after allowable deductions. Therefore where there was a hike in the higher rate of CGT to 40% from 28% this would result in a significant increase in the tax charge for higher rate tax payers.
What the Office of Tax Simplication doesn’t address was the fact that CGT for residential properties for higher rate and standard rate tax payers is now different from that charged on other assets which remain at 10% & 20% . That in itself is anomilous given the mandate of the OTS is about simplification. The Office for Tax Simplication have said that by aligning income tax and CGT it could bring in an additional £14 billion of tax if taxpayers such as landlords behaviour stays the same. That is never going to happen! Watch this space for further updates and advice on landlord tax.
CGT impact on landlord investment returns
Despite the potential expense many landlords fail to consider the potential impact on their investment returns of the Capital Gains Tax on a BTL property. The capital gains tax incurred on disposal of their investment property can reduce massively a landlord’s returns, so it’s worth considering this issue carefully. One way obviously to keep your capital gains tax bill down is obviously never to sell your buy-to-lets. At some stage though inheritance tax planning will come into play and landlords should consider potentially incorporation and holding their buy-to-lets in a limited company.
Confusion over Capital Gains Tax Changes
Some of the confusion of when Capital Gains Tax is payable can be traced back to the fact that the government changed the way that CGT is calculated. From April 2008 the complicated system of taper relief was scrapped. The system was originally introduced by Gordon Brown to discourage short term trading by rewarding individuals for holding on to their assets. Having introduced the system shortly after Labour got into power in 1997 Gordon suddenly decided ten years on that it was no longer such as good idea. Instead it was replaced by a flat rate of 18% on all capital gains regardless of how long a landlord has owned their property. So much for consistency!
Minimising a landlord’s capital gains tax burden – ways to save.
Landlords need to play the game of tax avoidance if they are not going to get hit by a huge tax bill.
The Principal Private Residence relief (PPR)
One of the best ways of side stepping the taxman is the rule that affects a home owners’ Principal Private Residence relief (PPR). This rule allows any landlord that has lived in their rental property as their main home at some time to significant reduce their potential CGT liability.
The question many landlords ask when considering PPR is: “how long do I need to have lived in a property to qualify me for the PPR relief?” The answer is – there is no specific time laid out in the tax legislation. Tax case law has emphasised the quality of occupation rather than the duration. The onus is put on the landlord to prove that they really ‘lived’ in the house and not occupied it as part of a tax dodge.
Details which a landlord can use to reinforce their case are:
1. Demonstrate that you have actually moved and furnished your property. A receipt from a removal firm would be useful supporting evidence.
2. Your official post; bank statements, utility bills, driving licence are all registered at your home address
3. The details for you on the electoral register shows this address
4. Your family, unless you are separated; are also shown as living at this address
Having established that you lived in the property as your main residence – what tax benefits will this confer on me?
What Capital Gains Tax can a landlord save?
Having established that the property was your PPR at some time in the past there are a number of reductions that this status can provide a landlord in their potential Capital Gains Tax liabilities:
1. Where a landlord had lived in a their buy-to-let property as their PPR; the period of occupation along with the 3 years of gains prior to disposal are exempt from the CGT tax liability; even where the landlord has not lived in the property for many years.
2. The period that you lived in the property as your PPR are also exempt from any capital gains.
Lettings Relief
Lettings Relief for landlords was up until April 2020 a very generous tax allowance to landlords that at some stage had lived in a rental property as their main home in otherwords as their Principle Private Residence. Prior to April 2020 this allowance allowed £40,000 per person so £80,000 in the case of a married couple and where the property was jointly owned to be offset against the capital gain on disposal. This Lettings Relief now only applies to a landlord that lives in the home at the same time as their tenant when the property is sold. In this case the owner / landlord will be entitled to the lowest of the following;
- the same amount you got in Private Residence Relief
- £40,000
- the same amount as the chargeable gain made while letting out part of your home
This provision will not be relevant to most buy-to-let landlords who don’t let out parts of their home but for a detailed exploration of the topic you can reference this forum discussion the new letting relief where a landlord shares with tenants.
The Government have retained the aspect of Letting Relief that allows a final period of exemption from the gain whether you were living at the property or not. However, this concession has been reduced from 18 month to 9 months from the 6th April 2020. This benefit is applicable to all landlords who have lived in the property previously regardless of whether you were living in the property at the time.
Previous owner occupation landlords also benefit from PRR exemption in relation to the time they lived in the property as their main home. So in simple terms if for example you lived in a property for 5 out of the 10 years of ownership you would only pay CGT on 4 year 3 months of the prorata gain as you would also benefit from the final period exemption referred to above.
The final period exemption is increased to 36 months for disabled landlords or where the seller goes into long term care. Full details can be found on the Governments own website about the tax you pay when you sell a home.
Tax relief available to all landlords
Landlords that haven’t ever lived in their buy-to-let property are still able to make significant reductions in their capital gains bill.
Firstly; in working out a landlords initial base costs for the purpose of a CGT calculations; item that can be included and which can be used to reduce CGT liabilities are:
- costs of acquisition – legal costs of buying the property investment.
- improvement costs – costs associated with improving the buy-to-let property such as addition of extension.
- costs of disposal – estate agency and legal fees.
A landlord also has their personal tax exemption which allows them to make a given amount of capital gains in any one tax year. This can be set against any CGT tax liability arising on disposal.
EXAMPLE 1- no occupation
The simplest way of explaining these concepts is way of a worked example. In this case let’s take a situation where:
Peter and Katy bought a letting property for £145,000 in June 2010 and then sold it in June 2020 for £375,000 after spending £20,000 on improving the property.
Purchase price £145,000
Cost of acquisition £5,000
Improvement costs £20,000
Sale costs £5,000
Base cost £175,000
Disposal proceeds £375,000
Taxable gain £200,000
As Peter and Katy are joint owners, each with a 50% stake in the property, they divide the taxable gain by 2, giving them £100,000 each subject to CGT AT 18%. After each deducting their annual allowance of £12,300 for 19/20 this gives them each a taxable gain of £87,700.
CGT paid by each is 18% * £87,700 = £15,786
EXAMPLE 2 – occupation by landlord
Taking the same couple Peter and Katy; but this time assuming they had lived in the property. The couple lived in the property together for a year and 3 months before moving out to buy another property. In this situation the following calculation applies.
Base cost £175,000
Disposal proceeds £375,000
Taxable gains £200,000
Peter and Katy each have a chargeable again of £100,000
However the PPR exemption means that the 1st year and 3 months of occupation and the final 9 months of capital gains are exempt. The result is that 2 out of the 20 years of taxable gains qualify for PPR exemption.
Chargeable gain £100,000
LESS PRR £10,000
Chargeable gain £90,000
LESS annual exemption £12,300
Taxable gain £77,700
Tax on £77,700 @ 18% £13,986
We can see that the tax savings of occupation are only small and pretty much entirely related to the time of occupation. Prior to the Lettings Relief changes this was not the case.
Tax saving tips on Capital Gains Tax
There are several very simple tips for a landlord in reducing their ultimate CGT liability.
1. Live in your buy-to-let at some stage. This may not always be practical for some landlords particularly those landlords who own large portfolios. However, if a landlord has; or is only thinking of putting together a small portfolio of property then living in these properties could seriously dent your ultimate CGT liability. Maybe the tip here is only buy property that you would be prepared to live in yourself. However, this option is no where near as attractive as it previously was prior to the April 2020 Letting Relief changes.
2. Get married and own the buy-to-let property jointly. This confers advantages in terms of each partner being able to offset their allowance against personal allowances and PRR relief for each partner.
This is a very simplistic run through of what is a very complicated area. We would always advocate that landlords should do as much work themselves to save costs; but getting expert tax advice on matters such as CGT planning and avoidance is one area where a little bit spent on specific expert advice could save you thousands.
For more advice on Landlord Tax:
Should landlords incorporate into a limited company?
How to avoid paying tax on rental property?
Landlords claiming property expenses
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I PURCHASE A PROPERTY IN 1980 FOR £7000 LIVED IN IT FOR TEN YEARS PAID COUNCIL TAX THEN RENTED IT OUT AND HAVE A £100,000 BUY TO LET MORTGAGE IF I SELL IT NOW FOR £300,250 WHAT WILL I HAVE TO PAY IN CAPITAL GAINS THANK YOU SO MUCH GLORIA MARTIN
SORRY RE PREVIOUS E.MAIL I MEANT £350,000 NOT £300,250 SOOORRREEEE
£350,000 minus the mortgage of £100,000 and the original purchase price of £7,000 leaves a capital gain of £243,000.
Subtracting your annual allowance of £12,300 leaves a taxable gain of £230,700.
So at 18% your CGT bill would be £41,526, leaving you to enjoy £201,474 of unearned income.
Not sure where your mortgage comes from James there wasn’t one in the example and it’s also irrelevant. You look at the buying and selling price regardless where the money came from.
If, before she sells, Gloria went and lived back in this property which is her PPR, would this help reduce her costs further?
The recent changes in lettings relief in relation to rental properties make this strategy far less effective than it was.
James has two things wrong with his reply. Firstly, the mortgage is irrelevant to CGT. The assessable gain is the difference between the purchase price and the sale price, less allowable costs such as solicitor, estate agent etc. and the cost of improvement (not repairs) during the period of ownership.
Private residence relief will be available for the period it was occupied as the principal private residence, and so the gain will be (if we assume £1,000 each associated costs of purchase and sale):
Sale proceeds £350,000 less costs of sale £1,000 = £349,000.
Acquisition costs £7,000 + associated costs of acquisition £1,000 = £8,000
Gross gain £349,000 – £8,000 = £341,000
PRR = £341,000 /41*10 = £83,170
Gain £341,000 – £83,170 = £257,830 – annual exemption £12,300 = £245,530.
Whilst some of the basic rate band may be available, the majority of this will be chargeable at 28%.
EDIT: Private residence relief would have the final 9 months added, and so would be:
£341,000 / 429 months x 129 months = £102,538.
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