Property Tax Life Cycle – A Case Study

Sarah Bradford highlights potential tax issues that might arise during the acquisition, ownership and disposal of property.

Alice and Olly meet at university, and after graduating they purchase their first home in Manchester for £140,000. They buy the property jointly, putting down a deposit of £20,000 and taking out a mortgage to fund the remainder. Legal costs associated with the purchase are £2,000.

Stamp duty land tax (SDLT) is payable on the purchase. The purchase price exceeds the current SDLT threshold of £125,000. At current (2015/16) rates, SDLT is payable on the excess over £125,000, (i.e. £15,000) at 2%. Therefore, on buying the property they must pay SDLT of £300 (£15,000 @ 2%).

For capital gains tax (CGT) purposes, the base cost of the property will be £140,000 plus the cost of acquisition (legal fees of £2,000 and SDLT of £300), i.e. £142,300. As they will live in the property as their main home, it will be their main residence for private residence relief purposes.

Alice and Olly live in the property as their main home for the next three years while they establish their careers. Alice then falls pregnant, and they decide to buy a larger property as a family home, while retaining the current property as an investment property. They purchase a new property for £300,000, funded by deposit of £50,000 and a further mortgage of £250,000 and let out the original property for £600 per month. The property is let unfurnished. The original property is now worth £180,000.

A property can only be a main residence if it is lived in as such. Although, as they are not married, each have their own main residence for PPR purposes. However, once they cease to live in the original property as a main residence it is no longer eligible to be considered as such for PPR purposes. Thus the original property no longer qualifies. Consequently, they do not need to elect for the new property to be their PPR – it is their only main residence.

On the acquisition of the new home they will pay SDLT. At current rates this will cost them £5,000 (i.e. (125,000 @ 0%) + (£125,000 @ 2%) + (£50,000 @ 5%)).

They will be liable to income tax on any profits from letting the original house. In calculating the profits they can deduct any revenue expenditure associated with the letting, such as letting agent’s fees, costs of advertising the property, cleaning costs, gardening costs, insurance and such like. They can also obtain tax relief for interest on borrowings up to the value of the original property when it was first let, i.e. £180,000 (rather than the original purchase price of £140,000). This means that in addition to the interest on the £120,000 mortgage secured on the original property, they can also claim relief for 60/250 of the interest in respect of the mortgage on the new house (to give relief on borrowings of £180,000). Relief is not available for the capital element of any mortgage repayments. For tax purposes, as the let property is jointly owned, Alice and Olly are each taxed on 50% of the profit. 

Following the birth of their daughter Poppy, they decide to get married. As Olly’s career is going well, they decide it would be beneficial for Alice to spend time at home with their daughter, so she gives up work. During this period, Olly pays tax at 40%. 

As Olly is a higher rate taxpayer and Alice’s only income is her share of the rental income, it makes sense to transfer the rental property into Alice’s sole name. She will then be taxed on all of the rental profit. As this is less than her personal allowance, there will be no income tax to pay on the rental profits. Had the property remained in joint name, Olly’s share of the rental profits would have been taxed at 40%.

It should be noted that a married couple can only have one main residence for PPR purposes between them. 

A couple of years later, Alice gives birth to twin boys. They need more space and decide to move to an area with better schools. They purchase a property for £500,000, and sell their current home for £350,000 and the rental property for £210,000. The new property is funded by a deposit of £150,000 and a mortgage of £350,000.

As with previous purchases, the purchase of the new home will attract SDLT. At current rates this will be £15,000 ((£125,000 @ 0%) + (125,000 @ 2%) + (£250,000 @ 5%)). The new property is now their only property and becomes their main residence for PPR purposes.

There is no CGT to pay on the sale of their former family home, as the property was their main residence throughout. Consequently, all the gain is covered by the PPR exemption.

The position regarding the let property is more complicated. The property was purchased for £140,000 and sold for £210,000. Costs of acquisition were £2,300 and costs of sale were £4,700. Therefore, they realise a capital gain (before reliefs) of £63,000 (i.e. £210,000 – (£140,000 + £2,300 + £4,700)).

The property is in Alice’s name only. Prior to sale, it is worth working out the tax implications to ascertain whether it would be beneficial to transfer it back into joint names. This will be the case if a gain arises which cannot be covered solely by Alice’s annual exempt amount for CGT purposes. Transferring the property back into joint names would mean that Olly’s exempt amount would also be available to shelter any gain.

At the date of sale, the property has been owned for six years, three of which as a main residence. As the property has been Alice’s main residence at some point in the period of ownership, the last 18 months of the gain is also exempt. This means that PPR relief is available for 54 months of the 72 months of ownership. PPR is therefore 54/72 x £63,000 = £47,250.

Lettings relief is also available as the property has been let and was the main residence at some point during the period of ownership.

Lettings relief is the lower of:

Therefore, lettings relief is £15,750.

Due to the availability of PPR (£47,250) and lettings relief (£15,750), the whole gain is sheltered and there is no CGT to pay. Consequently, there is no need to transfer it back into joint ownership prior to sale.

During the period of ownership of the original property, various taxes come into play – SDLT on purchase, income tax on the rental income and CGT on sale. While lifestyle changes may dictate the timing and nature of property acquisitions and disposals, being aware of the tax implications in advance can enable these to be undertaken in the most tax-efficient manner. 

For example, retaining their original property to let out, which had been their main residence, meant that lettings relief was available. If instead they had sold that property and bought another property specifically to let out, they would not have benefited from lettings relief, and may have had a CGT bill to pay on sale.