Currently, capital gains on the sale of residential property in the UK are reported on the self-assessment tax return and the total capital gains tax liability for the tax year is payable by 31 January after the end of the tax year. Thus, the capital gains tax on residential property gains arising in the 2019/20 tax year must be reported to HMRC on the 2019/20 self-assessment return by 31 January 2021 and the associated capital gains tax paid by the same date.
However, from 6 April 2020 this will change. From that date, gains arising on disposals of residential property by UK residents must be notified to HMRC with 30 days of the completion date, and a payment on account of the eventual tax liability made by the same date.
What disposals are affected?
The new rules will apply from 6 April 2020 to disposals by UK residents of UK residential property which give rise to a residential property gain. The rules applied to disposals by non-residents from April 2019.
A new return
Rather than notifying HMRC of the gain on the self-assessment return, there will be a new return for advising HMRC where a gain arises on the disposal of a residential property. If there is no taxable gain, for example if the property is disposed of to a spouse or civil partner on a no gain/no loss basis, there is no requirement to make a return.
The return must be submitted to HMRC within 30 days from the date of completion.
Payment on account of tax due
The taxpayer must also make a payment on account of the capital gains tax liability within 30 days of the completion date. This is considerably earlier than now, where the lag is at least nine plus months and may be as much as almost 22 months.
Amount to pay
The amount to pay is effectively the best estimate of the capital gains tax at the time of the disposal, taking into account disposals to date in the tax year.
Paul sells a second home, completing on 31 May 2020 realising a gain of £50,000. He has made no other disposals in 2020/21 at the time that the property is sold.
He can take into account his annual exempt amount (for purposes of illustration this is assumed to be £12,000 for 2020/21) when working out his liability. Paul is a higher rate taxpayer.
The payment on account is therefore £10,640 ((£50,000 - £12,000) @ 28%).
Where a capital loss has been realised before the residential property gain, this can be taken into account when calculating the payment on account.
The return must be filed and the payment on account made by 30 June 2020.
Rebecca sells her city flat, which is a second property, on 1 August 2020, realising a gain of £100,000. In May 2020, she sold some shares, realising a loss of £10,000. Rebecca is a higher rate taxpayer.
The loss can be set against the residential property gains of £100,000, leaving a net gain of £90,000. As her annual exemption is available, the chargeable gain is £78,000 and the payment on account is £21,840.
No account is taken of a loss realised after the residential gain.
Final capital gains tax liability for the year
The final capital gains tax liability for the year is computed via the self-assessment return taking into account all gains and losses for the year. The payment on account is deducted from the final bill and the balance payable by 31 January after the end of the tax year.
If the payment on account is more than the final liability, for example if losses were realised later in the tax year, a refund can be claimed once the self-assessment return has been submitted.
Partner note: FA 2019, s. 14 and Sch. 2.
Where a property qualifies in full for private residence relief, it is perhaps academic, from a tax perspective at least, whether a couple own it jointly or it is the one name only. In either case, the relief shelters any gain that arises and there is no tax to pay.
However, where a gain is not fully sheltered by private residence relief, as may be the case for an investment property or a second home, there can be very different tax consequences depending on how it is owned.
Take advantage of the no gain/no loss rules for spouses and civil partners
There are some breaks in the tax system for married couples and civil partners, and one of them is the ability to transfer assets between each other at a value that gives rise to neither a gain nor a loss. This can be very useful from a tax planning perspective to secure the optimal capital gains tax position on the sale of property where full private residence relief is not available. This enables a couple to utilise available annual exempt amounts and lower tax bands.
Capital gains tax on residential property gains is charged at 18% where total income and gains do not exceed the basic rate limit (set at £37,500 for 2019/20) and 28% thereafter.
Ron and Rita have been married a number of years and in addition to their main residence, they have a holiday cottage, which is owned solely by Ron. As their lives are busy, they no longer use the cottage much and decide to sell it. They expect to realise a gain of £100,000.
Rita does not work and has no income of her own. Ron is a higher rate taxpayer. Neither has used their annual exempt amount for 2019/20 (set at £12,000).
If they leave the property in Ron’s sole name, they will realise a chargeable gain of £88,000 after deducting his annual exempt amount of £12,000. As a higher rate taxpayer, this will give rise to a capital gains tax bill of £24,640 (£88,000 @ 28%).
However, as Rita has her basic rate band and annual exempt amount available, making use of the no gain/no loss rule to put the property in joint names prior to sale can save the couple a lot of tax. Each will realise a gain of £50,000.
As far as Ron is concerned, £12,000 of his gain will be sheltered by his annual exempt amount, leaving a chargeable gain of £38,000 on which tax of £10,640 will be payable.
Rita will also have a gain of £50,000, of which the first £12,000 is covered by her annual exempt amount, leaving a chargeable gain of £38,000. As her basic rate band is available in full, the first £37,500 is taxed at 18% (£6,750), with the remaining £500 being taxed at 28% (£140). Thus, Rita’s tax liability is £6,890, and the couple’s total tax bill is £17,530.
By taking advantage of the no gain/no loss rule to put the property into joint names prior to sale, the couple will be able to make use of Rita’s annual exempt amount and basic rate band, reducing the capital gains tax payable on the sale from £24,640 to £17,530 – a saving of £7,110.
Partner note: TCGA 1992, s. 58.
No capital gains tax liability arises if a gain occurs on the sale of a property which has been the owner’s only or main residence throughout the period of ownership then the gain is fully sheltered by private residence relief. However, there are advantages to be had if the property has been the only or main residence for part of the period of ownership – not only is that period covered by private residence relief but the door is opened to benefit from the final period exemption and, where the property has been let, lettings relief.
However, time is running out to benefit from these reliefs in their current, more generous, form.
Final period exemption
The final period exemption extends private residence relief to the final period of ownership where the property has been the owner’s only or main residence at some point in the period of ownership. Until the end of the 2019/20 tax year, the final 18 months of ownership is exempt. However, from 6 April 2020, this is halved to nine months, although, as now, it will remain at 36 months where the owner is disabled or goes into care.
Where a sale is on the cards, completion before 6 April 2020 will keep the last 18 months of ownership tax-free as long as the property has been the only or main residence at some point.
As it currently applies, letting relief can reduce the chargeable gain on a property that has been let and which has been the owner’s only or main residence at some point by up to £40,000. The relief reduces the chargeable gain by the lower of:
Consider selling before 6 April 2020
If a disposal is on the cards and you currently would benefit from lettings relief and/or the final period exemption, where possible aim to complete before 6 April 2020 to enjoy these reliefs in their current, more generous, form.
Partner note: TCGA 1992, s. 222, 223 and new s. 224A (to be introduced by the 2020 Finance Bill).
There may be a number of reasons why a property is occupied rent-free or let out at rent that is less than the commercial rate. This may often occur where the property is occupied by a family member in order to provide that person with a cheap home. For example, a parent may purchase a house in the town where their student son attends university and let it to the student, and maybe even his housemates, at a low rent to help them out. While the parents’ motives are doubtless philanthropic, their generosity may cost them dearly when it comes to obtaining relief for the associated expenses.
Wholly and exclusively rule
Expenses can only be deducted in computing taxable rental profits if they are incurred wholly and exclusively for the purposes of the property rental business. Unfortunately, HMRC take the view that unless the property is let at full market rent and the lease imposes normal conditions, it is unlikely that the expenses are incurred wholly and exclusively for business purposes. So, where the property is occupied rent-free, there is no tax-relief for expenses.
If the property is let at a rent that is below the market rent, a deduction is permitted, but this is capped at the level of the rent received from the let. This means that where a property is let at below market rent, it is not possible for a rental loss to arise, or for expenses in excess of the rent to be offset against the rent received from other properties in the same property rental business.
Periods between lets
Where there are brief periods where the property is occupied rent-free or let out cheaply, it may be possible to obtain full relief for expenses. For example, if the landlord is actively seeking a tenant and a relative house sits while it is empty, relief will not be restricted as long as the property remains genuinely available for letting. In their guidance HMRC state, that ‘ordinary house sitting by a relative for, say, a month in a period of three years or more will not normally lead to loss of relief’. However, if a relative takes a month’s holiday in a country cottage, relief for expenses incurred in that period will be lost.
Commercial and uncommercial lets
Where a property is let commercially some of the time and uncommercially at other times, expenses should be apportioned on a just and reasonable basis between the commercial and non-commercial lets. Any excess of expenses over rents in the period when commercially let can be deducted in the computing the profit for the rental business as a whole. However, an excess of expenses over rent when the property is let uncommercially are not eligible for relief.
Timing must also be considered – expenses relating to uncommercial lets cannot be deducted simply because they are incurred when the property is let commercially.
Partner note: HMRC Property Income Manual PIM 2130.
Although the way in which landlords obtain relief for finance costs on residential properties is changing, there is no change to the type finance costs that are eligible for relief.
What qualifies for relief
The basic rule is that relief is available for expenses that are incurred wholly or exclusively for the purposes of the property rental business, and this rule applies equally to finance costs. Relief is available for eligible finance costs where they meet this test.
The definition of finance costs includes mortgage interest and interest on loans to buy furnishing and suchlike. Relief is also available for the incidental costs of obtaining finance, as long as the interest on the loan is allowable. Incidental costs of loan finance include items such as arrangement fees, and fees incurred when taking out or repaying loans or mortgages.
Limit on eligible borrowings
A landlord can obtain relief for the costs of borrowings on a loan or mortgage up to the value of the property when it was first let. Buy-to-let mortgages are often more expensive than residential mortgages with interest charged at a higher rate. The loan does not have to be secured on the let property. Where a landlord wishes to buy a rental property and has sufficient equity in their own home, it may make commercial sense to release capital from the home by borrowing against it and using the money to purchase the rental property. Interest on the loan is eligible for relief, despite the fact the loan is not secured on the rental property.
No relief for capital repayments
Capital repayments, such as the capital element of a repayment mortgage or loan repayments, are not eligible for relief. Where the borrowings are in the form of a repayment mortgage, it will be necessary to split the payment between the interest and capital when working out the relief. The lender should provide this information on the statement.
Mervyn wishes to invest in a buy to let property. As he only has a small mortgage on his home, he remortgages to release £150,000 of equity.
Following the remortgage, he has a mortgage of £200,000 on his own home. Using the released equity, he buys a property to let for £150,000. He spends some time renovating the property in his spare time before letting it out. When the property is first let, it has a value of £160,000.
During the 2019/20 tax year, Mervyn pays mortgage interest of 10,000and makes capital repayments of £10,800. The property is let throughout.
Mervyn can claim relief for 80% of the interest costs – this is attributable to the borrowings of £160,000 (80% of the loan of £200,000), being the value of the let property when first let. The interest eligible for relief is therefore £8,000 (80% of £10,000). For 2019/20, 25% (£2,000) is relieved by deduction with the balance giving rise to a deduction from the tax due of £1,200 (75% x £8,000 x 20%).
No relief is available for the capital repayments.
Partner note: ITTOIA 2005, ss. 272A, 272B, 274A, 274B
At some point, a landlord is likely to incur legal and professional fees in connection with the running of their property rental business. It is easy to fall into the trap of assuming that these costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however, this is only part of the story. The landlord must also determine whether the costs are revenue or capital in nature. The rules also differ depending upon whether the accounts are prepared on the cash basis or using traditional accounting under the accruals basis.
The nature of the legal fees follow that of the matter to which they relate – so if the fees are incurred in relation to an item which is itself revenue in nature, the legal and professional fees are also revenue in nature. Likewise, legal fees that are incurred in connection with a matter that is capital in nature are also capital in nature.
Legal fees that are revenue in nature would include, for example, fees incurred to recover unpaid rent, while legal fees that are capital in nature would include fees incurred in connection with the purchase of a property.
Cash or accruals basis
Revenue items are deductible in computing profits regardless of whether they are prepared under the cash or accruals basis, although the time at which the relief is given will differ. Under the cash basis, the deduction is given for the period to which the expenditure relates, for the cash basis the deduction is given for the period for which the expenditure is incurred.
For capital expenditure different rules apply. No deduction is allowed for capital expenditure under the accrual basis, whereas under the cash basis, the treatment depends on the nature of the item – capital expenditure is deductible under the cash basis unless the expenditure is of a type for which a deduction is expressly forbidden. Items of the forbidden list include expenditure in or in connection with lease premiums and the provision, alteration or disposal of land (which includes property).
Example of allowable revenue items
A deduction for legal and professional fees will normally be allowed where they relate to:
Example of capital expenses
The following are examples of legal and professional fees which are capital in nature:
Leases can be tricky. The expenses incurred in connection with the first letting or subletting for more than one year are deemed to be capital and therefore not deductible – this would include the legal fees incurred in drawing up the lease, surveyors’ fees and commission. However, if the lease is for less than one year, the associated expenses can be deducted. Normal legal and professional fees on the renewal of a lease are also deductible if the lease is for less than 50 years; although any proportion of the fees that relate to the payment of a premium are not deductible.
If a new lease closely follows the previous lease, a change of tenant will not render the associated fees non-deductible. However, if the property is put to other use between lets, or a long lease, say, replaces a short lease, the associated costs will be capital and non-deductible.
Partner note: HMRC’s Property Income Manual PIM 2120