Sarah Bradford explores the draft Finance Bill changes to private residence relief for capital gains tax purposes.
In recent years, landlords and those with second homes have been on the receiving end of a raft of tax changes, which has hit them in the pocket. Unfortunately, there are more changes on the horizon, which will restrict lettings relief and halve the final period exemption.
Draft Finance Bill clauses were published in the summer, revealing what the legislation will look like (subject to any further amendments arising from consultation). The changes are not due to take effect until 6 April 2020, allowing landlords some time to benefit from the existing rules. Individuals who are planning to sell a property which has both been let out and, at some point, their main residence would be advised to consider selling prior to 6 April 2020, rather than waiting until after that date.
Private residence relief
Private residence relief is a valuable capital gains tax (CGT) relief, which shelters gains arising on the disposal of a property which is, or which has been, the owner’s only or main residence. Where the property has been the only or main residence throughout the period of ownership, the relief applies in full; if the property has been the only or main residence for some but not all the period of ownership, reduced relief is available.
There are significant advantages to occupying a property as a main residence, even if only for a short while; not only is private residence relief available for the period for which the property is occupied as such, the occupation as a main residence also opens to the door to further reductions, such as the final period exemption and lettings relief. However, changes to be introduced by the Finance Bill 2019—20 will reduce the benefit of these reliefs.
1. The final period exemption
Where a property has been occupied as an only or main residence at some point during the period of ownership, the gain arising in the ‘final period’ is exempt from CGT. Currently, the final period is 18 months (or 36 months where the person making the disposal is a disabled person or a long-term resident in a care home). However, from 6 April 2020 it will reduce to nine months (but will remain at 36 months for disposals by disabled persons and long-term care home residents).
If a disposal of a property which has been a main residence at some point but which is no longer (e.g. a former home that has been retained as a buy-to-let or second of holiday home) is on the cards, it could be financially advantageous to dispose of the property on or before 6 April 2020 to benefit from the 18-month final period exemption.
Example 1: What a difference a month makes!
Max has a flat that he brought on 1 January 2010 for £200,000. He lived in it as his main residence for two years. On 1 January 2012, he purchased a family home which has been his main residence since that date. He retained the flat as a city pad. He plans to sell the flat for £320,000.
Scenario 1 – Sale on 31 March 2020
If Max sells the flat on 31 March 2020, he will have owned the flat for a total of 10 years and three months (i.e. 123 months). During that period, he lived in it for 24 months as his only or main residence.
As the sale takes place prior to 6 April 2020, he will benefit from the final period exemption for the last 18 months.
The gain on sale is £120,000 (i.e. £320,000 - £200,000).
He qualifies for 42 months’ private residence relief – 24 months as his only or main residence plus 18 months final period exemption.
Private residence relied = £40,976 (i.e. 42/123 x £120,000).
The chargeable gain is therefore £79,024 (i.e. £120,000 - £40,976).
Scenario 2 – sale on 30 April 2020
If Max does not sell the flat until 30 April 2020, he will only benefit from a nine-month final period exemption. If he sells on this date, he will have owned the property for 124 months. By selling on 30 April rather than 31 March, he will only benefit from private residence relief of 33 months – 24 months when occupied as the only or main residence plus the nine-month final period.
Assuming the sale price remains at £320,000 and the gain at £120,000, the gain which is sheltered by private residence relief is £31,935 (i.e. 33/124 x £120,000), and the chargeable gain is increased to £88,065 (i.e. £120,000 - £31,935).
If Max is a higher rate taxpayer, the one-month delay will increase his tax bill by £2,531 (i.e. 28% (£88,065 - £79,024).
2. Lettings relief
Lettings relief is a valuable relief that is available on the disposal of a property which has at some time been the owner’s only or main residence and which has also been let out. The availability of the relief is to be curtailed significantly from 6 April 2020.
Under the current rules, lettings relief applies to shelter part of the gain arising on the sale of a property which has been let out as residential accommodation and which at some time was the owner’s only or main residence. The amount of the letting relief is the lowest of the following three amounts:
- the amount of private residence relief available on the disposal;
- £40,000; and
- the gain attributable to the letting.
Under the current rules, periods of residential letting count regardless of whether or not the landlord also lives in the property.
From 6 April 2020, lettings relief will only be available where the owner of the property shares occupancy with a tenant. From that date, lettings relief is available where at some point the owner of the property lets out part of their main residence as residential accommodation and shares occupation of that residence with an individual who has no interest in the residence.
Where the gain that would otherwise be chargeable to CGT because it relates to the part of the main residence which is let out as residential accommodation, it is only chargeable to CGT to the extent that it exceeds the lower of:
- the amount of the gain sheltered by private residence relief; and
- £40,000.
For disposals on or after 6 April 2020, lettings relief is lost unless the landlord shares the property with the tenant. Where a landlord plans to dispose of a let property which has been a main residence at some point (or which will be by the disposal date), it can be financially advantageous to dispose of the property prior to 6 April 2020. The landlord could also benefit from the 18-month final period exemption.
Example 2: Vanishing lettings relief
Mary buys a flat for £300,000, which she lives in for one year as her main residence. She then buys a new home which she lives in as her main residence and lets the flat out for three years, before selling it and realising a gain of £96,000.
Sale before 6 April 2020
Assuming the facts are as above if the disposal of the flat occurs before 6 April 2020, Mary will be entitled to private residence relief (before lettings relief) of £60,000 (i.e. 30/48 x £96,000). This comprises relief for the period she lived in the property as a main residence (i.e. 12/48 x £96,000 = £24,000), and the final period exemption (i.e. 18/48 x £96,000 = £36,000).
The gain attributable to letting is £36,000 (i.e. £96,000 – (£36,000 + £24,000)). Lettings relief is the lower of:
- amount of private residence relief - £60,000 (i.e. £24,000 + £36,000)
- gain attributable to letting - £36,000; and
- £40,000.
The lettings relief is, therefore, £36,000 and the total gain of £96,000 is sheltered. Consequently, there is no CGT to pay on the disposal.
Sale after 5 April 2020
Assuming the facts are as above if the disposal of the property takes place after 5 April 2020, lettings relief is not available as Mary does not share her home with the tenant. Further, the amount of private residence relief is reduced as the final period exemption is nine months rather than 18, meaning only 21 months qualify for the relief.
Private residence relief is now £42,000 (i.e. 21/48 x £96,000) and the remainder of the gain of £54,000, which is attributable to the letting, is chargeable to CGT.
Practical Tip:
To take advantage of the more generous rules for lettings relief and the longer final period exemption, consider advancing planned disposals of qualifying properties to before 6 April 2020.
