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

The UK Government, in the eyes of many Buy-To-Let Landlords and Landlord Associations, continued its cash grab on landlords in its November 2018 Budget.

This Guide was written by Iain Rankin, Landlord Tax Adviser at TaxKings Accountants. Iain now writes for Listentotaxman.com on matters relating to property tax and landlord tax. He is very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the TaxKings Accountants website for contact details.

This Guide was written by Iain Rankin, Landlord Tax Adviser at TaxKings Accountants. Iain now writes for Listentotaxman.com on matters relating to property tax and landlord tax. He is very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the TaxKings Accountants website for contact details.

Further to the previous increases in stamp duty (SDLT in England) and the restriction on mortgage interest tax relief - which we dealt with in this article - the Chancellor announced the removal of Lettings Relief, as well as a reduction of the deemed occupation period allowable under Principle Private Residence (PPR) relief from April 2020.

Who is affected by the change?

If you are an “accidental landlord” who has seen an increase in the value of your property that you used to live in, after April 2020 you will pay more Capital Gains Tax (CGT) when you sell that property. Those landlords who sell a property that they have never lived in are unaffected by this, though.

As our starting point, 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. You 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). 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.

A second proposed change 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. Currently, letting relief is the lower of:

  • the amount of PRR;
  • the amount of the gain that is chargeable by reason of the letting
  • £40,000

Letting Relief thus 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. A very valuable relief indeed.

From April 2020 however, 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 impact on an individual landlord will be to increase the chargeable gain on disposal by up to £40,000 (£80,000 for a couple).

In the opinion of HM Treasury, 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 CGT. The Budget reiterated that the lettings relief change will not affect owner-occupiers or landlords who have never lived in the property they are renting out.

When 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. From that date, only those periods where the owner was in shared occupancy with the tenant will qualify for lettings relief. Periods when the property was let out before then will not qualify for any relief.

The government is also considering changing the rules on spousal transfers, so that the receiving spouse inherits the transferring spouse's period of ownership and the use to which the property was put during that time. This would prevent an individual claiming full PRR on the disposal of a property that their spouse had previously owned and let out.

Worked Example of Withdrawal of Letting Relief

Dr Pepper makes a gain 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) resulting in 67.5% of gains being exempt from CGT. So Dr Pepper won’t pay any tax on £68,750 (£100,000*0.6875) 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. So his resulting tax bill, on a £100,000 profit would be precisely zero. Nada. Zilch.

From April 2020 the calculation looks rather different, and distinctly not in Mr Benn’s favour. 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. This assumes, of course, that all of his gain was taxed at 28% and that he has used his CGT Annual Exemption 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 £11,275 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.

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

Based on the government’s own calculations (and as seen in our example above) someone selling a property they once lived in, but then rented, could end up over £13,000 worse off than they would be under the current rules.

Some landlords will no doubt be considering moving into their rental homes for a brief period before selling so they still qualify for Lettings Relief. Not easily done however, if - like many affected - it’s a one bedroom flat or you have a young family.

For those who were considering selling anyway - due to the full loss of mortgage interest tax relief in April 2020 - then this may encourage these landlords to sell now, rather than seeing a potentially larger CGT bill if they sell after April 2020.

What are the Consequences of the changes?

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.

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 measures.

Here is a PDF document published by the Government on the CGT changes to ancillary reliefs

Summary

Some are already proclaiming the virtual removal of lettings relief, combined with the tweak to PRR, as yet another nail in the coffin for buy-to-let ownership following the 3% SDLT Surcharge on second homes and the cut in tax relief on mortgage interest payments for landlords. In reality, as the effects on professional landlords is marginal, this is unlikely. The tax burden will be borne by those already hard-pressed “accidental landlords” and the trend is likely to continue for professional landlords to protect their future property acquisitions through a limited company.

This Guide was written by Iain Rankin, Landlord Tax Adviser at TaxKings Accountants. Iain now writes for Listentotaxman.com on matters relating to property tax and landlord tax. He is very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the TaxKings Accountants website for contact details.

This article was published in our Guides section on 18/09/2019.

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