Capital Gains Tax on Buy-to-Let Property Key Insights
A buy to let property is a residential investment property that is purchased to let out to generate rental income. While this can be a lucrative investment strategy, knowing the potential capital gains tax implications when you eventually sell the property is important.
Capital gains tax is a tax levied on the profit you make when you sell an asset. The amount of tax you'll owe can vary depending on your other income and the asset sold. However, there are several strategies you can explore to reduce your capital gains tax liability and keep more of the proceeds from the sale.
In this blog post, we'll explore the key steps you can take to mitigate capital gains tax on your buy to let property investments.
What is capital gains tax?
Capital gains tax (CGT) is a tax that you may need to pay when you sell or dispose of an asset, such as a buy to let property, that has increased in value since you acquired it. The tax is calculated based on the difference between the price you paid for the asset (the "base cost") and the amount you receive when you sell it (the "disposal proceeds"), adjusted for any capital expenses and expenses incurred directly in acquiring or selling the property.
The rate of CGT you pay depends on your total taxable income. Basic-rate taxpayers typically pay 18% on residential property gains, while higher-rate taxpayers pay 24% (28% for tax year 2023/24 and earlier). It's important to understand the CGT rules and plan ahead to reduce the tax you owe when selling a buy to let property. Working with a tax professional can help you take advantage of all the available deductions and reliefs to reduce your CGT liability.
What is a buy to let property?
A buy to let property is an investment property that is purchased to rent it out to tenants. The primary goal of a buy to let investment is to generate rental income and potentially benefit from capital appreciation over time.
This type of investment is popular among individuals looking to diversify their investment portfolios, generate passive income, or build long-term wealth through property ownership.
The key characteristics of a buy to let property include:
- Purchased with the purpose of renting it out to tenants.
- Generates rental income for the property owner.
- Potential for capital appreciation over time as the property value increases.
Understanding the nature of a buy to let property is important when considering strategies to reduce capital gains tax liability upon the sale of the investment.
When do you pay capital gains tax on buy to let properties?
When it comes to buy to let properties, you typically pay capital gains tax in the following situations:
- Selling the property: If you sell your buy to let property for more than you originally paid for it, you will be liable for capital gains tax on the profit.
- Transferring/Gifting ownership: Capital gains tax may also be due if you transfer/gift ownership of the buy to let property to someone connected to you, such as a family member. Even if no money changes hand, CGT is payable.
You may be able to take advantage of s281, TCGA 1992 to pay the tax in instalments if you meet the qualifying conditions. - Inheriting the property: When you inherit a buy to let property, you may be liable for capital gains tax if you later sell it for more than its value at the time of inheritance.
- Changing the property's use: If you previously occupied a residential property as your main residence, but then rented it out, you may be liable for capital gains tax when you eventually sell the property. This is because the property was not occupied as your residence throughout the period of ownership.
The last 9 months of owning your home always qualify for tax relief, no matter how you use the property during that time, as long as it was your main home at some point. - Transfers as part of divorce settlement: Generally, any transfers between spouses or civil partners who are living together happen at no gain/no loss, such that there is no CGT to pay. But if the transfer is not a part of a divorce settlement, you may be liable for capital gains tax on your share of the property and CGT will have to be paid.
For disposals after 6 April 2023, spouses/civil partners have 3 years to transfer properties at no gain/no loss once they cease to leave together.
When assets are transferred as part of a formal divorce (or court separation) agreement, there is no time limit applied to the ‘no gain no loss’ treatment.
It's important to note that there are various reliefs and exemptions available that can help reduce or even eliminate your capital gains tax liability on buy to let properties. These include the annual capital gains tax allowance, which allows you to earn a certain amount of tax-free capital gains each year, as well as the ability to deduct certain expenses, such as the cost of improvements made to the property.
Capital gains tax rates on buy to let residential properties:
The amount of CGT you owe depends on several factors, including your total taxable income and the length of time you've owned the property.
Residential property gains:
For gains on residential properties that are not your main home, the CGT rates are 18% for basic rate taxpayers and 24% for higher and additional rate taxpayers.
Here's a breakdown of the capital gains tax rates on buy to let residential properties:
- Basic rate taxpayers: If your total taxable income, including the capital gain, exceeds the higher rate threshold (£50,271 in 2024/25), you'll pay 24% CGT on the gain (28% in 2023/24).
- Higher rate taxpayers: If your total taxable income, including the capital gain, exceeds the higher rate threshold (£50,271 in 2024/25), you'll pay 24% CGT on the gain (28% in 2023/24).
- Additional rate taxpayers: Individuals with a total taxable income, including the capital gain, above £150,000 will be subject to the additional rate of 24% CGT (28% in 2023/24).
It's important to note that the capital gains tax rates and thresholds are subject to change, so it's always best to consult with a tax professional to ensure you're aware of the latest regulations and how they apply to your specific situation.
Steps to avoid or reduce capital Gains tax on buy to let properties:
There are several strategies you can employ to reduce your capital gains tax liability when selling a buy to let property.
Utilise tax free capital gains allowance:
Every individual in the UK has a tax-free capital gains allowance, which is the amount of capital gains you can make before having to pay any tax. For the 2024/25 tax year, this allowance is £3,000. For 2023/24 it was £6,000. By timing the sale of your buy to let property to fall within this allowance, you can avoid paying any capital gains tax on the first £3,000 of your profits. Familiarise yourself with the current capital gains tax-free allowance and how it applies to your specific situation.
Plan the timing of your sale:
Consider the best time to sell your buy to let property to maximise the use of your tax-free allowance and carefully monitor your capital gains throughout the year to ensure you stay within the allowance.
Deduct relevant expenses:
When calculating your capital gains tax liability, you can deduct certain expenses related to the sale of your buy to let property. These can include:
- Improvement costs: Any money you've spent on renovations, extensions, or other improvements to the property which has enhanced the value of the property can be deducted from your capital gains.
- Legal and professional Fees: Costs associated with the sale, such as solicitor fees, estate agent commissions, and surveyor fees, can also be deducted. By carefully documenting and claiming these deductible expenses, you can significantly reduce your overall capital gains tax bill.
- Acquisition costs: Acquisition cost includes the original purchase price of the asset as well as any incidental costs incurred during the acquisition process, such as legal fees, stamp duty, and surveyor's fees. It is essential to keep detailed records and receipts of these expenses.
Consider joint ownership with a spouse:
If you own your buy to let property jointly with your spouse or civil partner, you can take advantage of both of your capital gains tax-free allowances (£3,000 for Tax Year 2024/25). This means you can effectively double the amount of tax-free gains you can make when selling the property. Ensure that the property is legally owned by both you and your spouse or civil partner. Coordinate the timing of the sale with your spouse or civil partner to plan the sale of the property to maximise the use of both of your tax-free allowances.
Option of holding rental properties in a limited company:
Holding your buy to let properties within a limited company structure can provide some tax advantages. Companies are subject to a flat rate of corporation tax, which is currently 19% for profits less than £50,000, rather than the higher personal income tax rates that apply to individual landlords.
Seek professional advice from a tax specialist or accountant to determine if this strategy is suitable for your specific circumstances.
Claim principal private residence relief:
If the buy to let residential property you're selling was previously your main residence, you may be eligible for Principal Private Residence (PPR) relief. This relief can exempt some or all of the capital gains from being subject to tax.
- Determine eligibility: Assess whether the property qualifies for PPR relief based on the length of time it was your primary residence.
- Calculate the exemption: Understand how to calculate the portion of the capital gains that can be exempt from tax under PPR relief.
- Provide necessary documentation: Be prepared to provide evidence to HMRC demonstrating the property's use as your main residence.
- Live in the Rental Property Before Selling: If you've been renting out a property but then decide to move in and live there for a period while the property is being let before selling, you may be able to claim partial tax relief. This is known as "lettings relief," and it can further reduce your capital gains tax liability.
- Calculate the exemption: Determine the portion of the capital gains that can be exempt from tax based on the time the property was your main residence versus the time it was rented out.
- Maintain accurate records: Keep detailed records of the property's use and occupancy to support your claim for lettings relief.
Temporary Job Relief Accommodation Relief
This relief applies when an individual is required to live away from their main residence for employment reasons. If the individual rents out their main residence during this period, they may be eligible for relief from CGT on any gain arising from the disposal of that property. The relief is available as long as the property remains their main residence and they intend to reoccupy it once their temporary employment ends.
Relief for Armed Forces
Members of the Armed Forces may be eligible for relief from CGT when disposing of their only or main residence while serving a tour of duty outside the UK. This relief applies even if the property is let out during the period of absence. The relief is available as long as the property was the individual's only or main residence before the start of duty began, and they intend to reoccupy it upon their return.
This relief ensures that military personnel are not unfairly disadvantaged by the nature of their service-related relocations.
By implementing these strategies, you can effectively avoid or reduce your capital gains tax liability when selling a buy to let property.
If you're looking for a tax advisor or specialist who can help you avoid or reduce capital gains tax on your buy to let property, consider the expertise of dns tax. As a leading provider of tax advisory services in the UK, dns tax has a deep understanding of the complex capital gains tax rules and can guide you through the entire process.
We have team of experienced tax professionals can help you identify strategies to reduce your capital gains tax liability, such as utilising your tax-free allowance, claiming relevant deductions, and exploring options like holding properties in a limited company structure. With their support, you can reduce your tax savings and reinvest the funds back into your property portfolio.
Choose dns tax as your trusted partner for capital gains tax planning on buy to let properties. Contact them today at 0333 2422 572, email dnstax@dnsaccountants.co.uk, or book a free consultation. Their team of experts is ready to help you navigate the complex tax landscape and achieve the best possible outcome.