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Landlords caught up in CGT schemes need to mug up on the rules

Tax Calculations

Tom Entwistle looks at landlord taxes and especially Capital Gains Tax for landlords.

The article discusses the implications for landlords of capital gains tax (CGT) and sets out a brief summary of the tax rules. It also highlights the ongoing efforts by HMRC (Her Majesty's Revenue and Customs) to target buy-to-let landlords, particularly those who transferred their rental properties to a company in the 2017/18 tax year. Landlords who incorporated their property business but did not report capital gains on their 2017/18 self-assessment tax return are being sent letters from HMRC.

Your self-assessment tax return

With the new tax year around the corner, thoughts turn to completing your tax return, if you’ve not already completed that annual chore – you’ve still got a full month to do it by the 31st of January. You need to be thinking about what needs to be declared from your activities this tax year and what items you can claim for. In my experience it’s better to get it done early and not have it hanging over you over Christmas.

If you’ve sold any properties there could be capital gains tax (CGT) to pay, and you also have income tax on your profits after deducting your full expense allowances. If you are using a limited company for your buy-to-let investments you have corporation tax and dividends to consider - your accountant will advise best on these.

HMRC warning

HMRC (Her Majesty's Revenue and Customs) is currently targeting buy-to-let landlords regarding their liability to pay CGT - capital gains tax. Whether accidentally or deliberately, it’s so easy to fail to declare capital gains when a property is sold.

HMRC’s “fishing” or “nudge” letters are being sent to landlords who they suspect may have forgotten to declare, particularly those who transferred their rental properties to a company as far back as the tax year 2017/18. For those affected, failure to respond within 30 days could lead to a tax investigation and financial penalties.

Note: This article applies primarily to England and is not a full interpretation of the law, only the tax tribunal and courts can decide. Rules change and although laws are similar in other jurisdictions, there may be significant differences. Always seek professional advice before making or not making important decisions. Use this guide as the starting point for your research.

Transferring a property into a limited company

There are some tax advantages when you run a buy-to-let property through a limited company, but not everyone benefits from this, so consult a tax advisor. Landlords who incorporate their property business and transfer an existing property into the company’s ownership may have capital gains tax to pay because you have to “sell” rather than transfer.

Capital gains tax is payable on a rental property only when you sell a property that has increased in value since the time of purchase. CGT is calculated on the profit made through the sale not on the total sale price of the property. The formula is: Selling price less purchase price, as well as buying and selling costs, plus any capital expenditure (those costs you could not claim on annual expenses) made on the property during the period of ownership. It’s important to keep a record of all these costs and expenses for when you come to sell a property, which could be years later.

Always keep a file on every property you purchase. To maximise your capital gains tax (CGT) allowance you need proof of the purchase price and costs of purchase (solicitor’s fees etc), along with all capital expenditure during the period of ownership, along with the selling price and selling costs.

Tax avoidance schemes

HMRC took the unusual step of issuing what is calls a Spotlight notice, a warning notice (Spotlight 63) in October this year regarding a tax avoidance scheme involving a “hybrid business model” (a partnership and a company) that in HMRC’s view breaches the UK tax code. Landlords who entered into the scheme are being advised by tax experts to withdraw from the scheme immediately and settle their tax affairs with HMRC.

HMRC believes that some buy-to-let landlords, those who have incorporated, either have not paid the relevant CGT when they sold their existing properties to sell to a limited company, and/or they entered into a scheme or schemes to avoid income tax. The warning letters are to put landlords on notice that HMRC has them “in their cross hairs”.

The avoidance scheme works roughly as follows:

1. individual landlords set up a limited company and a limited liability partnership (LLP), and they then transfer their properties to the LLP;

2. the individuals plus the company are the members of the LLP (the company being a corporate member); and

3. the LLP then allocates any profits to LLP members on a discretionary basis. It ensures that the individual members remain as basic-rate taxpayers. Any profits in excess are then allocated to the corporate member, which is subject to corporation tax and can also claim a deduction for finance costs.

HMRC has come to the view that the scheme does not work and is caught by existing legislation.

As a landlord it’s important to plan well ahead with your tax affairs and understanding capital gains tax liabilities is an important part of that – think strategically to minimise tax and maximise profits and to help with that you should speak to a tax advisor.

What is your CGT allowance?

All UK resident landlords will have their capital gains tax allowance, known as the annual exemption. It’s a personal allowance so you and your spouse, for example, both have this annual tax-free amount to set against any capital gains you make, say from property or stocks and shares, which are owned separately of jointly.

The annual personal exemption in the current tax year (6 April 2023 to 5 April 2024) is £6000. This was previously £12,300, and under the Government’s austerity measures it will reduce further to £3,000 in the next tax year (2024-2025). Capital gains tax is only payable therefore if your total gains for the tax year exceed your annual exemption amount.

If your rental property is owned jointly (say by you and your spouse) then both of you can use your combined capital gains tax allowances against the same property.

What are the capital gains tax rates for landlords?

Capital gains tax rates on a property sold by landlords is in two bands: which band you’re in will depend on your marginal income tax rate. If you are a basic rate taxpayer the CGT rate of 18 per cent applies, whereas a higher rate taxpayer pays at the rate of 28 per cent.

The rates of CGT for rental residential property sales are different than other types of assets. The normal rates are set at either 10% or 20%, so if you are selling assets other than residential property, check with your accountant which rates apply.

An example CGT calculation on a rental property:

You purchased the property for £250,000 and some years later it brings £395,000 on the sale. Your gain therefore is £145,000. This increase in value, the gain or (profit) is subject to CGT.

If the sale is in the current year your tax-free allowance for CGT is £6,000, and assuming the property is owned jointly with your spouse this would be £12,000 combined.

Reducing the £145,000 by £12,000 leaves a gain subject to tax of £133,00.

However, your purchase costs totalled £2,300, refurbishment and structural repairs (improvements) amounted to a capital expense of £10,000 and you spent another £6,000 on costs not allowable as expenses during your period of ownership, all for which you have invoices to show HMRC. In addition to those the selling costs amounted to £2,250

So, all told you have a further £20,550 to claim against your gain, leaving £112,450 subject to CGT at either 18 percent or 28 percent depending on your individual tax status.

You will find more information from HMRC here as well as an online tax gain calculator for CGT which is free and easy to use.

If you don’t own the property jointly it is sometimes possible to transfer a property into joint ownership prior to the sale to take advantage of a spare CGT allowance.

Private residence relief

There is also a further CGT relief if you have previously lived in the rental property as your main residence or in situations where you rent out a part of the dwelling while living in the rest. The rules for this are quite complex so seek professional advice.

Non-resident capital gains tax

Starting from April 6 2015 capital gains tax was applied to direct disposals of UK residential properties made by UK residents landlords living overseas. This tax net was expanded from April 6 2019 involving all direct and indirect disposals of land and property in the UK.

CGT and rollover relief

Rollover CGT Relief is possible for furnished holiday lettings businesses. It means that providing you reinvest some or all of the proceeds of a furnished holiday let sale your will be in position to defer some or all of the CGT otherwise due. This relief is not available for buy-to-lets as these are classed by HMRC as investments rather than businesses.

New rules on reporting and paying Capital Gains Tax

HMRC has considerably shortened the time you have available for reporting and paying CGT. UK residents and non-residents who dispose of a second property or a buy-to-let residential property must report their CGT liability and pay to this to HMRC within 60 days of the sale – the date of completion.

Capital Gains Tax for limited company landlords

You won’t pay CGT on buy-to-lets owned by you in a limited company. Instead, you'll be subject to Corporation Tax when you take the profit out of the business. Yon won’t therefore be entitled to an allowance. Whether you gain from incorporation will depend on your own particular financial situation and how much profit you make from the sale of your buy-to-let

Tags:

Tax investigations
Income tax
Capital gains tax

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