Sarah Bradford looks at the implications of selling a let property and asks whether individual landlords can afford to sell.
Landlords have been the target of many adverse tax changes in recent years, one of the most controversial of which is the restriction of interest relief for residential lets. With rising interest rates pushing up mortgage costs, many landlords may be questioning whether letting property remains worthwhile and evaluating whether now is a good time to sell.
The recent announcement that the capital gains tax (CGT) annual exempt amount is to fall from 6 April 2023 (combined with the likelihood of a falling property market) means that landlords who do want to sell may be advised to do so before 6 April 2023. Where selling the property will realise a chargeable gain, the landlord will need to consider how they are going to fund the associated CGT.
Interest relief
The way that relief is given for mortgage interest and other finance costs depends on the type of let. For commercial lets and furnished holiday lettings, the mortgage and finance costs are deducted when computing the taxable rental profit, the effect of which is to give relief at the landlord’s marginal rate of tax.
However, where the let property is a residential property, relief is given by deducting 20% of the landlord’s interest and finance costs from the tax due on their rental profit. Landlords paying tax at the higher or additional rate only receive basic rate relief on their interest costs, increasing the hit from rising mortgage costs.
Where the let property is highly mortgaged, rising interest rates may mean that the letting is no longer viable.
No tax relief is available for any capital repayment element of the mortgage.
Capital gains tax
A CGT liability is likely to arise where an investment property is sold at a profit. Private residence relief will only shelter the gain to the extent that the property has been occupied as an only or main residence (for example, if the landlord retained a former home and let it out)and including the final nine months of ownership. Lettings relief is now only available where the landlord lives in the property with the tenants.
As there is now no relief for inflationary gains, recent increases in property prices will often mean that the landlord will sell the property for more than they paid for it, resulting in a capital gain. Where the landlord has owned the property for many years, the inflationary gain may be significant, triggering a large CGT bill (even where there is little or no gain in real terms).
CGT is payable on net gains to the extent that they exceed the annual exempt amount. Allowable losses are set against the gain before applying the annual exempt amount. However, the annual exempt amount is applied before any reduction for losses brought forward from previous tax years.
In the Autumn Statement, the Chancellor announced that the annual exempt amount is to fall from its current level of £12,300 to £6,000 for 2023/24 and to £3,000 for 2024/25. Spouses and civil partners have their own annual exempt amount. Making use of the rules that allow transfers between spouses and civil partners on a no gain/no loss basis will ensure that both partners’ available annual exempt amounts can be accessed. The reduction in the annual exempt amount will increase the CGT payable by a higher rate taxpayer on a residential property by £1,764 (£6,300 @ 28%) if completion takes place in 2023/24 rather than in 2022/23. For a couple, delaying completion beyond 5 April 2023 will increase the tax bill by up to £3,528 as a result of the fall in the annual exempt amount.
60-day payment window
CGT on residential property gains must be reported to HMRC within 60 days of the completion date, and a payment on account of the tax must be made within the same window. The amount due is the best estimate of the tax due on the gain at the time, taking account of other disposals and the availability of the annual exempt amount.
The capital gains position for the tax year is finalised in the self-assessment return to take account of other gains and losses in the year.
Funding the tax
Ideally, the landlord will be able to fund the CGT from the gain that has been made on the property; at worst, the tax is only 28% of the gain made after deducting allowable costs.
However, where the landlord has taken advantage of rising property prices to release equity, perhaps to provide a deposit for the purchase of further properties to let, the landlord may find that having sold the property at a significant gain, there are no funds available from which to pay the tax.
It should be noted that where a let property is remortgaged, tax relief is only available on borrowings up to the market value of the property when it was first let. Where the property has risen in value and the landlord’s mortgage now exceeds that value, the interest qualifying for relief will be capped.
Case study: Remortgaged property
Monty purchased a property to let in 2005 for £200,000. The property was funded with a £20,000 cash deposit and a mortgage of £180,000. The property has been let as a residential let since completion.
As the market value increased, Monty remortgaged the property on several occasions to release equity to provide the deposits for further property purchases in order to expand his letting portfolio.
The property is now worth £600,000, on which Monty has a £580,000 mortgage.
Monty is an additional rate taxpayer. He is only able to obtain tax relief for the interest on £200,000 of the mortgage (the value of the property when first let) at 20%. He must fund the remaining mortgage interest in full.
Rising mortgage costs mean that Monty is no longer achieving the desired return and wishes to sell the property.
Over the years, he has spent £50,000 on capital improvements on the property. The cost of buying was £5,000, and the cost of selling is £10,000.
He makes no other disposals in 2022/23. It is assumed he sells the property for £600,000
If he completes before 6 April 2023, his CGT position is as follows:
|
|
£ |
£ |
|
Sale proceeds |
|
600,000 |
|
Purchase cost |
(200,000) |
|
|
Improvement expenditure |
(50,000) |
|
|
Costs of sale (£5,000) and disposal (£10,000) |
(15,000) |
|
|
Allowable expenses |
|
(265,000) |
|
Net gain |
|
335,000 |
|
Annual exempt amount |
|
(12,300) |
|
Net gain |
|
322,700 |
|
CGT @ 28% |
|
90,356 |
If Monty sells the property before 6 April 2023, he will trigger a CGT liability of £90,356 which must be paid within 60 days of completion.
From the sale proceeds of £600,000, Monty must clear the mortgage of £580,000 and pay the associated costs of disposal of £10,000. This only leaves £10,000 towards the CGT bill of £90,356. To pay the CGT bill, he must find £80,356 within 60 days of completion from funds elsewhere. This may prove difficult.
What are the lessons?
If remortgaging an investment property to take account of the rising market in order to release equity, remember that if the property is sold, the gain will crystalise, triggering a CGT liability. If there is insufficient equity left in the property to pay the tax bill, the funds will need to be found from somewhere else. If the property is a residential property, the window to do this is only 60 days from completion.
Consequently, when remortgaging, ensure that sufficient equity is left in the property to meet the disposal costs and pay any CGT that would arise if the property was sold for its current market value. Remember, the fall in the annual exempt amount will increase the CGT bill from April 2023 and the funds that have to be found to pay it.
Practical tip
If you are thinking of selling an investment property, check that you have sufficient funds available to pay any resulting CGT. Particular care should be taken if equity has been released.
