The draft Finance Bill published on 11 July 2019 confirmed the government’s plans to remove letting relief for landlords and reduce the deemed occupation period allowable under Principle Private Residence (PPR) relief. If you’re a landlord, you need to understand how this could impact you.
In brief, if you’re a landlord and you sell a property, you may have to pay more Capital Gains Tax.
Commencing in April 2020, lettings relief will only apply when the owner/landlord shares the same roof as their tenant(s). In addition to this, there is a proposed reduction of the deemed occupation period allowable under Principle Private Residence relief. Currently, if you have lived in the property for a period of time but not for the full duration of ownership, the last 18 months are automatically exempt. However, the change to deemed occupation period would reduce the exemption period from 18 months to 9 months.
What is lettings relief
In the simplest terms, lettings relief is a valuable relief for landlords which aims to lower the Capital Gains Tax (CGT) payable when selling a property which has been let out, but at some point in time was their main residence.
Normally, if you are selling your main home you get what’s called Private Principle Residence Relief (PPR). This ensures that no CGT is paid on the gains if the property has been your main and only residence throughout the period of ownership.
Lettings relief aims to protect those who have let out their former main property, to make sure they aren’t hit with a very large CGT bill for any increase in value of their property upon selling.
What is Capital Gains Tax?
You might be thinking, what on earth is CGT? Don’t worry, we can explain. Capital Gains Tax is the tax on the profit when you sell an asset at an increased value. This includes gifting or transferring, swapping or receiving compensation such as an insurance payout.
CGT applies to property assets which are not your main residence and personal possessions worth more than £6000 (not including your car). It also applies to a property if you let it out, if it is used for business, or if it is very large. Your main home is currently considered exempt from CGT provided it has been your main residence throughout its ownership, qualifying it for PPR.
Remember that when you are calculating your gain (i.e. your profit from the increased value of your property) you can add any extra costs to the purchase price, to reduce the amount gained. These extra costs can include any improvements you made to the property whilst you owned it, any solicitors fees, stamp duty or other legal fees that went into the sale process. By doing this you are increasing your cost of the property which then decreases the chargeable gain as your profit will be lower.
How it currently works in practice
Let’s look at how it currently works using a simple example…
Ramona bought a property in January 2000 for £100,000. This property is her main residence until she moves out and lets it out in January 2006. The property is sold in 2010 for £200,000. Ramona has owned the property for a total of 10 years, or 120 months. PPR is available for the period she lived in the property as her main residence which was 6 years, or 72 months. She is also entitled to the last 18 months of ownership, making it a total of 90 months.
On selling the property Ramona has made a gain of £100,000, which is the sale price minus the original purchase price. PPR is available for 90 months of the 120 months Ramona has owned the property, or 90/120ths of the gain, which equates to £75,000. The remaining amount of £25,000 is what the CGT will be applied to.
This is where lettings relief becomes relevant. Currently, lettings relief is the lower of PPR relief amount, lettings chargeable gain amount or £40,000.
In Ramona’s case, she would not be charged any CGT.
How lettings relief will change come April 2020
With the new changes in lettings relief, the outcome could look very different for Ramona. Instead of being able to add the last 18 months of ownership as deemed occupation period, it would be reduced to 9 months. This gives Ramona PPR on 81 months instead of 90 which is £67,500. The remaining chargeable gain would be £32,500.
As Ramona did not live at the property while letting it, she can no longer claim for lettings relief making £32,500 her final chargeable gain. If we assume that Ramona is a basic-rate taxpayer, she would pay 18% on the gains made, which equates to a tax bill of £5,850. As you can see, we have gone from £0 CGT to £5,850 which would have quite an impact on Ramona.
Higher and additional rate taxpayers would pay 28% CGT, which is even more significant.
What it means for landlords
This puts pressure on property owners looking to sell as they are essentially given 9 months to sell their homes after they move out rather than 18. The likelihood of owners looking to sell quickly in order to avoid CGT becomes higher.
By changing the lettings relief to be applicable only to landlords living in the same property as their tenants, it discourages from letting out as side project. It instead encourages the movement of property and could be an attempt to improve the housing market.
These changes come into effect on 6 April 2020 and apply to any property sales on and after that date. If you’re a landlord thinking about selling, you may want to attempt to complete the process prior to the change to avoid the higher CGT.
For further information or advice on how to plan for the change in lettings relief, please contact our team or check out our landlord accountants page.