Capital Gains Tax & Properties

Private residences – CGT on sale of private residences that have been let – important changes in Budget 2018.

The 2018 Budget included proposals to make important changes to the capital gains tax (CGT) treatment of properties that have been used by the owner as a private residence for part (but not all) of the period of ownership, and let out for the rest of the period.

This could have a substantial impact on “accidental landlords” – those people who are unable to sell a private residence when they move house, and so are forced to let the property out.

Currently, when such a property is sold, any capital gains will be apportioned between amounts that are taxable and those that are tax-free.

To ascertain the tax-free element, it is necessary to determine the principal private residence (PPR) relief. This equates to the period that the taxpayer has occupied the property as a private residence and is expressed as a percentage of the whole period of ownership. This percentage is then applied to the total gain to determine the tax-free element.

In this respect, the last 18 months of ownership (“the final period exemption”) is treated as a period throughout which the property was occupied as the taxpayer’s main residence, even if the investor was not so occupying the property because it was, for example, let out.

Example

John bought a house in Milton Keynes on 1 December 2008 for £200,000. He lived in it until 1 June 2012 when he bought a new house that he moved into. He then let his Milton Keynes property. He sells the Milton Keynes property for £400,000, on 30 November 2018.

The capital gain is £200,000. The tax-free element is based on the fact that he occupied the house as a private residence for three and a half years and is entitled to treat the last 18 months of ownership as a period of occupation as a private residence. Therefore five years (out of 10) is treated as the period of private residence. This means that 50% of the gain (£100,000) is tax-free.

Therefore, the taxable capital gain is £100,000. From this taxable gain can be deducted the letting allowance.

At present, people who rent out a property which was previously their main residence are eligible for lettings relief. This means accidental landlords, who owned a private residence but have since moved to a new residence and let the original property, are given a tax relief when they come to sell.

Lettings relief is only available where PPR relief can be claimed – in other words, where the property being sold has been the taxpayer’s main residence at some point during their period of ownership. Lettings relief works on the same basis as PPR relief in that it is available in respect of the part of the gain attributable to the period of letting. However, it is restricted to the lower of the amount of PPR relief given and the sum of £40,000.

Continuing the example of John above, the fraction of John’s gain attributable to the period of letting would be five years (ie. the remainder of the period of ownership not covered by PPR relief).

To calculate the proportion of the gain attributable to the period of letting, it is therefore necessary to multiply the gain by the fraction 5/10. This provides a figure of £100,000. Lettings relief is given at the lower of:

  • the gain attributable to the period of letting – £100,000;
  • the amount of private residence relief that is given – £100,000; and
  • £40,000.

In this case, John’s letting relief would therefore be restricted to £40,000, leaving £60,000 potentially chargeable to CGT.

So, for example, in the case of John (above), who is a higher rate taxpayer, lettings relief can save him a further £11,200 (28% of £40,000) of CGT.

Lettings relief can increase to £80,000 (possibly £22,400 of CGT) for a married couple/civil partners.

The two proposed changes in the Budget are:

  •  that the final period exemption will reduce from 18 months to nine months. There will be no changes to the 36 months final period exemption available to disabled people or those in a care home.
  •  the lettings allowance will only apply if the taxpayer occupied the property as a residence whilst the property was let ie. the landlord and tenant share occupation.

Both of these changes are scheduled to apply from 6 April 2020 and are subject to prior consultation.

COMMENT

Conventional buy-to-let landlords will be little affected by these proposed changes, since both reliefs are only available when a person’s primary residence is rented out.

However, the changes will hit those who have been unable to sell their homes and have decided to let their property instead. As sales have slowed across the country (particularly in the south) in recent years, more owners have chosen this option and it is these property owners who will suffer.

For those who have let, or are letting, a property that they previously occupied as a private residence and who are thinking about selling the property, it might be advisable to sell before 6 April 2020.

The Budget was not totally lacking good news for landlord investors, however, as the personal allowance increase to £12,500 and the basic rate tax limit increase to £37,500 will mean that more people will only be basic rate taxpayers, as more income can fall below the basic rate tax threshold – £50,000 (where the full personal allowance is available).

So, for landlords who have income approaching this figure and are now basic rate taxpayers, they may well qualify for cheaper mortgage financing. This is because some lenders apply less stringent rates in their income calculation ratio (ICR) assessments for non-taxpayers and basic rate taxpayers.

However, the 50% reduction in the final period exemption may pose a problem for separating or divorcing couples whose former family home is being sold. One partner – and owner of the property – may have moved out at the beginning of the divorce process, which can take a lot longer than nine months. Having to pay CGT incurred on exceeding the nine months final period exemption time limit would therefore generate another expense for someone going through a divorce.

We will keep you up to date with further developments.