Sarah Bradford explores the tax implications of ending a property rental business and selling up.
Rising interest rates and limited tax relief for interest have resulted in many landlords questioning whether now is the time to quit renting their property and to sell it instead, taking advantage of recent property price increases before the market crashes. However, there are likely to be tax consequences of selling up and these need to be taken into account.
Capital gains tax
Where the property has risen in value since it was purchased, selling the property may trigger a capital gains tax liability. If the property has been used purely as a rental property, the full amount of the gain will be taxable.
In arriving at the gain, allowable costs can be deducted. These include the original cost of the property plus the costs of acquisition, such as stamp duty land tax, solicitor’s fees and suchlike. The cost of any improvement expenditure, such as an extension or new kitchen, can also be deducted, as can the costs of disposing of the property.
Where a capital gain arises in respect of a residential property, the gain must be reported to HMRC within 60 days, and a payment on account of the tax due made within the same time frame. This is done using the online service available on the Gov.uk website.
In working out the tax due, account is taken of any other gains or allowable losses in the tax year to date, and also the extent to which the annual exempt amount remains available. If the taxpayer has unused capital losses from previous years, these, too, can be used. Capital gains tax on residential property gains is charged at 18% where income and gains fall within the basic-rate band, and at 28% where they fall in the additional or higher-rate band. The tax position for the year is finalised when the self-assessment account is filed.
Private residence relief
If the let property has at some time been the owner’s only or main residence, some private residence relief will be available to reduce the chargeable gain. The private residence relief covers the period for which the property was the owner’s only or main residence and the final nine months.
Private residence relief may be available for a former residence which was retained and let out when moving to a new home.
Example
Jodie owned a two-bedroom flat prior to her marriage. On marrying Tom, the couple purchased a new home together. Jodie retained her flat as a rental property.
To provide funds to enable her and Tom to move to a larger home, she sells the flat in 2023. The sale completes on 31 January 2023.
Jodie purchased the flat on 1 February 2013. She lived in it for four years, moving into her new marital home on 1 February 2017. She rented the flat out until it was sold.
The flat was purchased for £150,000 and sold for £290,000. The costs of acquisition and sale were £10,000.
Jodie makes a chargeable gain of £130,000. She owned the property for ten years (120 months). Private residence relief is available for the four years for which she occupied it as her main home (48 months) and the final nine months – a total of 57 months. The relief is worth £61,750 (57/120 x £130,000), reducing the gain to £68,250.
Jodie’s annual exempt amount for 2022/23 of £12,300 is still available. The chargeable gain is, therefore, £55,950. If Jodie is a higher-rate taxpayer, she must pay capital gains tax of £15,666 (£55,950 @ 28%) within 60 days of the completion date and report the gain to HMRC within the same window.
Lettings relief
Lettings relief is now only available where the landlord lives in their home at the same time as the tenants. Where part of the home is let out, the let part does not qualify for private residence relief. However, lettings relief may reduce the chargeable gain. The amount of lettings relief is the lowest of the following amounts:
- the amount of private residence relief;
- £40,000; and
-
the amount of the chargeable gain relating to the let part.
Example
Since purchasing her property, Betty has rented the top floor of her home to tenants and continued to live in the property at the same time as the tenants. The let part comprises one-third of her home.
Betty sells the property in January 2023, realising a gain of £300,000. She is only eligible for private residence relief on 2/3rd of the gain. This equates to £200,000.
As she lived in the property at the same time as the tenants, she also qualifies for lettings relief. This is the lowest of the following amounts:
- £200,000, being the amount of private residence relief;
- £40,000: and
-
£100,000 being the chargeable gain relating to the let part.
The lettings relief is, therefore, £40,000, reducing the chargeable gain to £60,000.
Spouses and civil partners
The capital gains tax rules allow spouses and civil partners to transfer assets between them at a value that gives rise to neither a gain nor a loss. This opens up tax planning opportunities prior to the sale, making it possible to change the ownership structure to utilise available annual exempt amounts and basic-rate bands. This is illustrated by the following example.
Example
Colin has owned a rental property for five years. He plans on selling the property and will realise a gain of £100,000. He is a higher-rate taxpayer. His annual exempt amount for 2022/23 is still available. If the sale completes before 6 April 2023, the chargeable gain will be £87,700 and Colin will pay capital gains tax of £24,556 (£87,700 @ 28%) on the gain.
Colin’s wife, Catherine, has not used her annual exempt amount for 2022/23. She also has £17,700 of her basic-rate band remaining.
If Colin transfers a 30% stake in the property to his wife prior to sale, she will realise a gain of £30,000, against which she can set her annual exempt amount of £12,300, leaving a chargeable gain of £17,700. As a basic-rate taxpayer, she must pay capital gains tax of £3,186 (£17,700 @ 18%).
The remaining £70,000 of the gain accrues to Colin. Applying his annual exempt amount of £12,300 reduces the chargeable gain to £57,700, on which Colin pays capital gains tax of £16,156 (£57,700 @ 28%).
Colin and Catherine’s combined capital gains tax bill is £19,342. Had Colin been taxed on the full amount of the gain, he would have paid capital gains tax of £24,556. By taking advantage of the rules to transfer a 30% stake to Catherine to utilise her annual exempt amount and basic rate band, the couple is able to save tax of £5,214.
Timing and the annual exempt amount
The annual exempt amount is £12,300 for 2022/23. However, it is reduced to £6,000 for 2023/24 and is to fall again, to £3,000, from 6 April 2024.
Completing the sale prior to 6 April 2023 will, where not already used, allow £12,300 of the gain to be sheltered by the annual exempt amount. For a couple, this is £24,600. Completing the sale before 6 April 2023 rather than after this date could potentially save a couple £3,528 in capital gains tax ((2 x (£12,300 - £6,000)) @28%).
Furnished holiday lettings and rollover relief
Furnished holiday lettings have a number of advantages, one of which is the option to roll over the gain. If the proceeds are reinvested in a qualifying replacement property, the gain can be rolled over by reducing the base cost of the new property by the amount of the gain. This has the effect of delaying the tax payable on the gain until the replacement property is sold. The relief must be claimed.
Can you afford to sell?
Before selling the property, it is wise to consider where the funds to pay the tax will come from. If the property is mortgage-free, this is unlikely to be too problematic as the tax can be paid from the sale proceeds. However, if the property has been remortgaged to release equity as it has increased in value, there may not be sufficient equity left in the property to pay the tax. As capital gains tax on residential gains must be paid within 60 days of completion, the window to find the necessary funds is tight.
It should also be noted that the capital gains tax system does not provide any relief for inflationary gains, and where the property has been owned for many years, the capital gains tax hit may be significant. Consideration should be given as to whether this is a hit worth taking.
Practical tip
Before selling the investment property, check whether any tax reliefs are available to reduce the gain and also that you can afford to pay the tax and take the tax hit.
