Accidental landlords’ costs set to spiral

New capital gains tax rules could cost accidental landlords thousands of pounds when they sell their former home in changes that were confirmed by HMRC. The new rules could affect over half a million landlords when they come to sell, Brona MacDougall takes a closer look at the details and the implications.

Measures announced earlier this year to curb private residence relief for landlords who once lived in their rental property will now come in to force next year. Currently, homeowners who previously lived in a property but went on to let it out can claim capital gains tax relief on property sales for up to 18 months after they move out. But from April 2020, this private residence relief will be cut from 18 months to 9 months and the Government is also scaling back on lettings relief too.

The tax break was originally designed to help those who had to move for work and were either unable to sell their home or chose to rent. In fact, many home owners are still unaware that the ‘final period exemption’ was reduced from 36 months to 18 months in 2014.

These major changes are expected to raise £470million for the Treasury over the next 5 years and it could affect up to half a million so called accidental landlords.

‘An accidental landlord is someone who didn’t buy a property intending to rent it out but due to their personal circumstances has ended up doing so. For example, they could have inherited the property from a family member or moved in with a partner and decided to keep their own property in the short term. Or they may have struggled to sell their home before buying their new home’.

What are the changes?
Any profit made on an investment property is subject to capital gains tax when it’s sold. For landlords this means that they can expect to be taxed on the difference between the price they bought a property for and the price that they sold it for.

Everyone has a capital gains allowance of £12,000 a year. But on any profit above that, a basic rate taxpayer would have to pay 18 per cent in tax on the gain. A higher rate taxpayer would have to pay 28 per cent on the gain.

If a landlord rents out a property that was once their main home, capital gains tax only applies on the pro-rated gain in sale associated with the period when they did not live in the property.

Currently, landlords can also add an extra 18 months onto the amount of time they lived at the property, this is known as the ‘final period exemption’. It has just been confirmed that this will be reduced to 9 months, potentially costing landlords thousands of additional pounds when they move.

What will this mean?
Under the current rules a landlord who has owned their property for ten years and lived in it for two years would only be taxed on six and a half years of capital gains, that’s the ten year period minus the two years of residency and the added 18 months relief.

From April next year however, they’ll be taxed on seven years and three months of capital gains, that’s the ten years minus the two years residency plus the reduced 9 months relief.

Lettings relief also being scaled back
The Government is also scaling back lettings relief, which can be hugely valuable to those who let out properties they once lived in over the long-term.

Currently, when a landlord sells their former home after renting it out, a maximum of £40,000 of their gain is exempt from capital gains tax and for couples this can be up to £80,000.

Under the new rules however, only landlords who live in the property with their tenants will qualify for this benefit from April 2020. This will mean that very few sellers will qualify for lettings relief if they sell their home after 6th April 2020, as there will be no ‘grandfathering rights’ in the legislation to allow letting relief in periods prior to 6th April 2020.

In Summary
Experts believe there could be an exodus of accidental landlords rushing to sell their properties before April next year, this increase in supply could even cause house prices in some areas to fall. It is important that property owners review their portfolios now to identify any large uncrystallised gains that are currently relievable but will not remain so.

However, the relatively short period of time before the new rules are introduced means that some accidental landlords may face barriers to selling, for example they may be tied into a fixed mortgage deal with hefty exit fees for selling early.

These new rules add to the long list of measures introduced by the Government over the past few years that have made owning buy-to-let properties much less attractive. Other changes have included the fact that buy-to-let investors now have to pay an additional 4% land and buildings transaction tax on property purchases, while several tax incentives have also been removed.

If these changes apply to your own situation, please don’t hesitate to contact one of the team for help and advice on the tax implications.