Investing in buy-to-let property has become a popular means of increasing income. Income tax is paid on the rental income received, but Capital Gains Tax (CGT) will be due if the rental property is sold and a profit is made. Capital Gains Tax is charged on profits realised on disposing of assets.
The rate of tax applied varies depending on the type of asset and the individual’s overall financial position. There are a number of tax reliefs and exemptions which can reduce the potential tax bill.
If you’re selling property that isn’t your primary residence, there are ways to reduce the amount of Capital Gains Tax you’ll need to pay. These include utilising your tax-free allowance, jointly owning the property with a spouse, deducting your costs, setting up as a limited company, and qualifying for private residence relief.
Buy-to-let property is generally thought of as residential property but could also be commercial property, such as a shop or factory. Whilst there is little difference between the tax rules for income on a residential and commercial rental property, the CGT rules are very different.
Why do you have to pay Capital Gains Tax on buy-to-let?
Capital Gains tax is charged on profit made on the disposal of all assets, subject to some allowances and exemptions that are available in certain circumstances. Buy-to-let property is no different in this respect and is treated as an investment for CGT purposes.
How is it calculated?
Capital Gains Tax is charged on the difference between how much you paid for the property and how much you receive for selling it or whatever it is worth if you are giving the property away.
There will be allowances for legal fees, stamp duty and estate agent fees if you have paid those in respect of the property being disposed of.
If you have improved the property, the costs incurred may also be available to reduce the Capital Gains Tax bill. The cost of replacing fittings in a house, such as bathrooms, windows and kitchens, is unlikely to be allowed for CGT purposes because they are considered repairs unless there has been a significant upgrade from the old fittings.
This restriction generally works in the favour of a landlord since these costs can be offset against income tax on rents, which gives a more significant tax saving than would be given through Capital Gains Tax relief.
The size of the CGT bill will depend on how much income you receive in the tax year. A higher rate taxpayer will pay tax at 28% on the chargeable gain on selling a residential property, whereas those with lower income may be able to pay a lower rate on part of the gain.
Basic rate taxpayers will pay tax on the capital gain on disposal of residential property at 18%, to the extent that they have a basic rate tax band available after considering their income.
What can I do to minimise CGT?
As an individual, there are some reliefs that help avoid Capital Gains Tax and reduce the tax on property sales.
(1) Private Residence Relief
The most valuable of these is private residence relief. Private residence relief only applies to periods during which the owner actually lives on the property. However, you only get this relief if you have lived in the buy-to-let property for a period of time.
The relief is calculated by apportioning the gain realised on the property between the period you occupied the property as your only or primary residence and the remainder of the period of ownership. You don’t need to get values of the property at particular dates, as the rules only consider the average of the gain accumulated.
Lettings relief was available on a property that had been a main residence before April 2020. However, CGT reliefs on properties used as the primary residence were cut at that time, including the withdrawal of letting relief.
The rules around private residence relief are complex, and HMRC is unlikely to agree to allow the relief if they believe you only lived in the property in order to claim private residence relief.
(2) Tax-free allowance
Each UK resident individual and certain non-residents are entitled to a CGT tax-free allowance each tax year of £12,300 up to 5 April 2023. The tax-free allowance is halved for the 2023/24 tax year to £6,000.
This allowance is set against the total Capital Gains realised in the tax year. Still, where a mix of disposals attracts different tax rates, the relief can generally be allocated most tax-efficiently.
(3) Joint ownership
Married couples can reduce their tax by switching ownership of the buy to let between them ahead of the sale to make the best use of the tax-free allowances available to them. Alternatively, they can use a lower tax rate where one spouse is a basic rate taxpayer, and the other pays tax at higher rates.
If the reliefs available to the individual still leave a Capital Gains Tax bill, the purchase of certain assets will allow the taxpayer to defer all or some of the tax by “rolling over” part of the gain into the purchase price of the new asset.
(4) Limited Company
A limited company will pay corporation tax on the rental profits and profits from property sales, which tends to be lower than the tax rates that would apply if the landlord owned the properties personally. This approach may only be suitable for some landlords, and it is important to get professional advice before incorporating your property business.
Can I deduct my mortgage from the gain on a property sale?
If you borrow money to purchase a buy-to-let property, the debt is part of the purchase price, so there is no additional relief available for the debt if you sell the property. The mortgage interest payments will attract income tax relief against the rental income.
Do I have to buy another house to avoid Capital Gains?
Buying another house does not reduce the tax bill on selling properties.
How do I report and pay Capital Gains Tax on property sales?
A new system was introduced in April 2020 for reporting the sales of residential properties owned by individuals, including buy-to-let. So, rather than reporting the disposal on a Self Assessment return and paying CGT the following 31 January, there is a stand-alone return to complete online. You must pay CGT within 60 days of completing the sale.
You must apply through a government gateway account online to make the return. This has to be done by the individual, and an agent cannot request a reference, even if HMRC has authority from the taxpayer to deal with that agent.
There are many reasons why an individual may not be able to request the CGT reference online, so HMRC will take requests for references over the phone and the deadlines for submitting the return and making the payment are adjusted to accommodate postal delays.
If there is no tax to pay on a buy-to-let property sale, there is no requirement for a UK resident taxpayer to submit the CGT return. However, all residential property sold by non-residents must be reported, even where no tax is payable.
The 60-day return extends to all UK property sales, including commercial property and land for taxpayers who are not residents of the UK.
Taxpayers who complete Self Assessment tax returns must also report the disposal of their buy-to-let on the annual return covering the year of sale of the property, even though it has already been reported on the 60-day return.
What happens if you don’t pay Capital Gains Tax?
The first thing to be aware of is that there are different rules for paying Capital Gains Tax than other taxes. From April 2020, the gain has to be reported within 60 days of completing property sales. Failing to submit the return by the deadline will likely attract a penalty charge. If you pay CGT late, interest will be applied to the unpaid balance.
Is it better to own buy-to-let properties through a Limited Company?
That will very much depend on individual circumstances. A basic rate taxpayer will benefit less from the properties being in a company than higher rate taxpayers. From April 2023, Corporation tax will increase to 25%, which is higher than the basic rate of income tax.
The company structure works best when the individual does not need to access the profits generated from the buy-to-let.
If you are considering setting up a Limited Company, it is important to obtain professional advice.
Can I avoid paying CGT by giving my buy to let to my family?
It depends. Giving property to your spouse or civil partner is not subject to Capital Gains Tax (CGT), but if the property is subject to a mortgage, stamp duty may apply to that transfer.
Giving property to other family members will be taxed as though it was a sale of the property at its market value. This can give rise to a CGT bill without cash having changed hands.
A trust might be an attractive alternative where the property is worth less than £325,000, as the Capital Gain that arises on transferring the property can be deferred.
The CGT bill does not disappear if you transfer your rental property to your spouse or into a trust; it is merely transferred to the recipient with the property, so it will be taxed when they dispose of the property.
The buy-to-let market is going through many changes at the moment, with more on the way in the coming years. The purchase of an investment property is a significant outlay, and it is important to seek advice to achieve the best financial position.
Butt Miller Chartered Accountants offers a comprehensive advisory service to help you through the process of owning property from purchase to sale.
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