Iain Rankin looks at some of the possibilities for landlords to potentially reduce or defer capital gains tax liabilities.
With lettings relief now virtually abolished, what options do landlords have left at their disposal?
Many landlords began their climb up the property ladder by renting out their previous main home. Until April 2020, such individuals were able to take advantage of lettings relief (LR) when selling rental properties where they previously resided.
While any profit made upon disposal would be subject to CGT, LR provided up to £40,000 of tax relief (or £80,000 for jointly owned property). Paired with the CGT annual exemption, LR could make a sizeable dent in (or completely negate) a seller’s CGT bill.
Disappearing relief (almost)
Unfortunately, from 6 April 2020, LR is only applicable if the property owner is sharing occupancy of the home with a tenant, thus excluding the vast majority of landlords from utilising this once valuable relief.
In addition, the government imposed a reduction in private residence relief (PRR). For disposals of ‘cheaper’ homes, the effect of PRR was overshadowed by that of LR, but it was still incredibly useful for those who had rented their property for under 18 months before selling.
Previously, PRR meant that landlords were not required to pay CGT for any years in which their rental property was their primary residence, plus an additional exemption for the last 18 months of ownership. From April 2020, this additional exemption is reduced to nine months.
With tax relief options for UK landlords increasingly scarce, it is worth assessing the remaining options that still allow these individuals to mitigate CGT.
When a property is jointly owned, a 50% share of ownership and profits is assumed. While some readers will be aware of facilities such as ‘declarations of trust’ and unequal shares for non-married couples, we will take this as the default position for most landlords.
Example 1: Sale of buy-to-let property
Jamie is a higher rate taxpayer, with a pre-tax salary of £70,000 and a buy-to-let (BTL) rental property. Following a string of less-than-ideal tenants, Jamie sold the property in May 2020, making a pre-tax profit of £32,300.
After deducting the CGT annual exemption of £12,300, Jamie pays CGT at a rate of 28% on the remaining £20,000, a total of £5,600.
Jamie’s partner, Alex, has no income. Had they jointly owned this BTL property, a profit split of 50% would automatically have been assumed by HMRC, reducing the tax due on both rental income and on disposal of the property.
Their combined tax-free CGT allowances would have reduced the £32,300 profit to £7,700 (i.e. £3,850 each):
Jamie would pay £3,850 x 28% = £1,087
Alex would pay £3,850 x 18% = £693
A combined total of £1,780.
Partnerships and ownership splits
If a formal partnership is registered with HMRC, it is possible to split the profit share for both rental income and on disposal of the property. Partners are able to allocate their profit share as they see fit.
If Jamie and Alex had registered a partnership, they could gain further savings thanks to this flexibility.
Example 2: Property partnership
The profit share in this example is optimised for CGT purposes, by assuming that Jamie had been entitled to 38%, and Alex 62%.
Jamie’s share of the profit is £12,274 (i.e. £32,300 x 38%). This is entirely absorbed by Jamie’s annual CGT exemption of £12,300.
Alex’s share of the profit is £20,026. After deducting Alex’s annual CGT exemption, a total of £7,726 is subject to CGT at 18%.
By avoiding Jamie’s CGT higher rate of 28%, but optimally utilising their tax-free allowances, the combined CGT liability is now £1,391.
Furnished holiday lettings
it is not surprising that the post-April 2016 mortgage interest restrictions have motivated many landlords to switch their residential properties into short-term holiday lets.
However, the benefits of furnished holiday lettings (FHLs) do not stop there. Rather than being treated as a personal asset, qualifying FHL’s can be treated as a business asset, widening the possibilities for mitigating CGT.
Business asset disposal relief
For both basic and higher-rate taxpayers, business asset disposal relief (BADR) (previously known as entrepreneurs’ relief) has the effect of reducing the CGT rate to 10% on the first £1 million of lifetime gains. This can be claimed upon disposal of part of the business, or the entire business.
However, the business owner must be able to prove that they owned the business for at least two years prior to the date of disposal.
Note: for FHL’s held within a company, there are further conditions to be met. The definition of a ‘personal company’ needs to be considered (TCGA 1992, s 169S(3)). Consult your tax adviser, if necessary.
Upon the transfer of a business asset, holdover relief (HR) allows payment of a CGT liability to be deferred until the recipient disposes of the asset. When gifting a property or other valuable asset to a spouse or civil partner, no CGT liability arises. But when gifting to relatives, the gift is treated as a disposal at market value.
A qualifying FHL is categorised as a business asset; therefore, if the transferor and transferee both make a claim for HR, no CGT payment generally becomes due upon the date of transfer.
Note: Any held over gain may become chargeable if the recipient moves abroad. Gift relief can also be restricted if the business asset was not wholly used for the business in the transferor’s period of ownership (see TCGA 1992, s 168 and Sch 7, para 5 respectively).
If, upon disposal of a business asset, the profits are reinvested in a new business asset, it may be possible to claim rollover relief (RR). Similarly to HR, RR allows the CGT payment to be deferred until the replacement asset is sold.
However, if the replacement asset is lower in value than the disposal proceeds, only partial relief is received, and some CGT payment will be due.
Qualifying as a FHL
Unfortunately, qualifying for the above reliefs is easier said than done. To qualify as a FHL, properties must be located within the UK or EEA, furnished to standards suitable for normal occupation and be commercially let with the intention to generate profit.
Additionally, there are three statutory conditions enforced by HMRC: (1) the availability condition; (2) letting condition; and (3) pattern of occupation condition.
To meet the requirements for the availability condition (1), FHL properties must be available to let for a minimum of 210 days per year. The letting condition (2) requires that the FHL property actually is let commercially for at least 105 days per annum. The pattern of occupation condition (3) places a limit of 31 continuous days per letting, with a total of 155 days annually. HMRC wants to ensure that FHL businesses are legitimately providing short-term holiday style lets; the conditions clearly define the practices of such a business.
Calculating the gain
When selling a property, you may deduct the costs of buying, selling or improving your property from the gain for CGT. Typical examples are:
- The costs of buying and selling (e.g. estate agents’ fees, solicitors’ fees, stamp duty, etc.);
Costs of improvement works - such as adding a conservatory or an extension.
Normal maintenance and repair costs do not count.
While there are still some viable options for mitigating CGT on property disposals, it’s obvious that the criteria for who can utilise them is becoming increasingly narrower.
While a move to FHL properties clearly brings the greatest benefits, such businesses require a higher degree of maintenance than traditional long-term rentals; HMRC’s strict requirements will also dissuade many from making the switch.
When dealing with CGT on properties, there are many moving parts, particularly with FHLs and the potential reliefs. Incorrect treatment can incur penalties and a considerable amount of grief. Consult a tax adviser, if necessary.