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What exactly does the removal of lettings tax relief mean for landlords?

The latest attack on landlords was during the October 2018 Budget, with the focus this time on the sale of their investment property.

Rita4Rent Michael Wright This Guide was produced by Michael Wright, Landlord Tax Expert at Rita4Rent, who are specialist landlord tax advisors, and the sole recommended tax advisors of the Residential Landlords Association. Michael now writes for Listentotaxman.com on matters relating to property and landlord tax. RITA4Rent are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Rita4Rent website for contact details.

Rita4Rent Michael Wright This Guide was produced by Michael Wright, Landlord Tax Expert at Rita4Rent, who are specialist landlord tax advisors, and the sole recommended tax advisors of the Residential Landlords Association. Michael now writes for Listentotaxman.com on matters relating to property and landlord tax. RITA4Rent are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Rita4Rent website for contact details.

There has been wave after wave of attacks: increases in stamp duty (SDLT in England), the restriction on mortgage interest tax relief (Section 24), and the removal of the wear and tear allowance.  The latest attack announced by the Chancellor at the October 2018 Budget was the announcement that Lettings Relief would be removed from 6 April 2020 onwards, as well as the private residence relief that applies for the last 18 months being reduced to 9 months on this same date.

Who is affected by these changes?

A typical example is a so-called “accidental landlord,” who has seen an increase in the value of their property that they used to live in, and after April 2020 they may pay more Capital Gains Tax (CGT) when that property is sold. Those landlords who sell a property that they have never lived in are unaffected by these changes.

Let’s look the current position of those landlords who ARE affected by the change. Most reading this will know that when you sell a property that is not your main home, you are normally liable to pay Capital Gains Tax (CGT). However, if the property was once your main home then how much you owe would depend on when the property was rented out and how long you lived there. Currently, you don’t have to pay any CGT for the years that you lived in the property. In this instance, you would also benefit from an additional exemption for the final 18 months that you owned it, even if you weren’t living there at the time. You then pay tax on your “chargeable gain”, which is your profit from sale less any Private Residence Relief (PRR), less any other relevant reliefs/deductions. In effect, PPR relief protects main homes from CGT.  The November 2018 Budget announced a proposed change in the final exemption period, reducing it from 18 months to 9 months. There will be no change for people who are disabled or people selling for the purpose of moving to a care home. In these instances, the last 36 months will remain exempt.

The second proposed change at this Budget, however, involves those landlords who rent their property following a period of occupation before sale, and concerns something called ‘Lettings Relief’.  Typically, PPR relief would be claimed for the period(s) of occupation plus the last 18 months of ownership then Letting Relief would be claimed for those period(s) when the property was let.

At present, and prior to the new rules kicking in, letting relief is the lower of:

  • the amount of PRR;
  • The gain while the property has been let out, that is not covered by PPR;
  • £40,000

So as you can see, Letting Relief therefore provided up to £40,000 of exemption (£80,000 for a couple) to those landlords who rent a property that was previously their main residence. So to some landlords, this will be a huge loss. 

It is proposed that lettings relief will only apply where the owner is sharing occupancy of the home with the tenant(s) under the same roof. This effectively abolishes it for buy-to-let purposes.

The reason for this change by the Government, was that they felt Lettings Relief was being used for purposes beyond the original policy intention, allowing landlords to claim lettings relief on a property that they have not lived in for a long time. The intention presumably is to discourage landlords from “flipping” their own properties to avoid paying Capital Gains Tax. When the changes come into effect for disposals on or after 6 April 2020, it is expected that around 40,000 people each year will be affected.

Example showing the effects of the Letting Relief changes

Let’s illustrate these changes with an example.  Dr Pepper makes a gain (after deducting legal fees etc) of £100,000 on the sale of the property he has lived in for 4 out of the 8 years of ownership. He met and moved in with his new partner, Mr Salt, halfway through the period of ownership and decided to rent out his ”old” property. Now he has decided to sell. Currently, he gets PPR relief for four years plus the last 18 months (so five and a half years or 68.75% of the period of ownership).  So, Dr Pepper won’t pay any tax on £68,750 (£100,000*68.75%) of the gain. The remaining 31.25% (£31,250) is his chargeable gain. However, under current rules, lettings relief is applicable to the remainder. So, this means that Dr Pepper can claim a valuable £31,250 in lettings relief - £31,250 being the lower of the amount of PRR, the chargeable gain and £40,000. Therefore his resulting tax bill, on a £100,000 profit would be precisely zero. Result.

However, from April 2020 the calculation looks very different, much worse. The £68,750 figure above falls to £59,375 (£100,000*0.59) covering the four years of ownership and the final exempt nine months. This means a higher chargeable gain.  More alarmingly, no Letting Relief can be applied. That means that Dr Pepper will incur a CGT bill of £11,375 (£100,000-£59,375x28%). This assumes, of course, that all of his gain was taxed at 28% and that he has used his CGT annual exempt amount elsewhere. He could still end up paying nothing if he gets his timings right, with advice from his professional tax adviser. Otherwise this represents an increased tax bill of £11,375 for Dr Pepper

This letting relief removal and PPR final period change will not affect landlords who have never lived in the property they rented out. But as Dr Pepper owned a property that he once lived in, and also let to tenants, he is affected.

What can I do to avoid this a potentially higher CGT Bill?

The first reaction from many landlords will no doubt be to consider moving into their rental homes for a brief period before selling so that they still qualify for Lettings Relief. However, this is not easily done, if - like many affected - it’s a one bedroom flat or you have a young family.  In addition, the intention should be that it is genuinely your main residence.

This may be the final nail in the coffin for those landlords who were considering selling anyway - due to the full loss of mortgage interest tax relief in April 2020.  It may encourage these landlords to sell now, rather than seeing a potentially larger CGT bill if they sell after April 2020 when the new rules are due to be in place.

What are the consequences of the changes?

The main landlord organisations suggest that after April 2020, the prospect of a higher CGT bill will almost certainly act as a serious deterrent to anyone thinking of letting their home for a time prior to selling, while those who have already gone down that route may be put off selling their property.

On the other hand, for those who have to sell – which would include those who have had to relocate for work, or those who have separated from their partner who either 1. didn’t want to sell up immediately or 2. were unable to find a buyer – these “accidental landlords” may well be hammered with much higher tax bills as a result of these changes.

Summary

As we said at the start of this feature, this is just the latest in a long line of attacks targeting landlords.  Arguably though, this is more likely to affect “accidental landlords” than professional investors.  As we mentioned in another article, there have been attacks on the more professional landlords, such as the restriction in finance costs (Section 24), and this has fuelled the growth in operating through a limited company.  Of course, if you are affected by these changes to PPR and Lettings Relief, you should take action now before it is too late, and by action we mean take professional tax advice from property specialists such as Rita4rent, to see what the best course of action is.  It is always better to plan ahead, rather than look backwards, and with April 2020 fast approaching, time is of the essence.

Rita4Rent Michael Wright This Guide was produced by Michael Wright, Landlord Tax Expert at Rita4Rent, who are specialist landlord tax advisors, and the sole recommended tax advisors of the Residential Landlords Association. Michael now writes for Listentotaxman.com on matters relating to property and landlord tax. RITA4Rent are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Rita4Rent website for contact details.

This article was published in our Guides section on 04/11/2019.

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