HMRC target landlords
The news this week was that HMRC are being more rigorous than ever in coaxing cash out of landlords. Latest reports are that they are systematically using Land Registry details to ensure that they collect all the Capital Gains Tax (CGT) due to them.
Property Hawk has explained previously how landlords can save large amounts of income tax by employing clever avoidance techniques.
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.
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 has recently 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.
The other big relief for landlords who have lived in one of their rental properties as their main home is lettings relief. This allows a landlord up to a maximum of £40,000 capital gain for letting their property. This relief is available for each person with an interest in a buy-to-let property so if it’s jointly owned; each of the owners would potentially benefit from a £40,000 reduction in their CGT liability.
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 1998 and then sold it in June 2008 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 £10,100 for 09-10 this gives them each a taxable gain of £89,900.
CGT paid by each is 18% * £89,900 = £16,182
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 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 of occupation and the final 3 years of capital gains are exempt. The result is that 4 out of the 10 years of taxable gains qualify for PPR exemption.
Chargeable gain £100,000
LESS PRR £40,000
LESS letting relief £40,000
Chargeable gain £20,000
LESS annual exemption £10,100
Taxable gain £9,900
Tax on £9,900 @ 18% £1,782
The result therefore, for one years of occupation in this case is that a landlord living together reduces their overall tax bill by £14,400 each; or for the couple by £28,800. A massive saving in Capital Gains Tax.
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.
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.