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Selling a Buy to Let Capital Gains Tax

Selling an investment property triggers liability based on the increase in value of the asset during ownership, minus certain costs. Where you have lived in a property as your main home , for any point of your ownership, the period is discounted when calculating the gain – in a process called “appointment”.

How CGT is applied

The rate of tax you pay on capital gain is calculated by adding the taxable gain to your taxable income.

If you remain within the basic rate tax band, you will pay 18% tax on the gain. If you fall into the higher rate tax band, you will pay 28%on at least some of it.

For 2015-16, the personal income tax allowance is £10,600 and the basic rate band is £31,787. Anyone with income over £42,385 pays higher rate tax on the excess. Everyone is entitled to tax free capital gains, worth £11,100 this tax year. Only gains above this are taxed.

If you earn £20,000, for example, and make a taxable gain of £10,000 (after your £11,100 annual allowance), the £30,000 total will fall within the basic rate band and you will pay 18% CGT.

If on the other hand you earn £35,000 and make a taxable gain of £25,000 you will be in the higher rate band. The £7,385 of the gain which is still within the basic rate band will be taxed at 18%, while the amount over £42,385 will be taxed at 28%.

Aside from well-known steps to reduce your CGT bill, such as transferring a share of the property to a spouse to utilise their CGT allowance, private letting relief and principal private residence relief, there are some little-known tricks that can save you thousands.

Use your pension

By making a lump sum contribution to your pension, you could save up to £4,000 on your CGT bill.

All pension contributions worth £40,000 a year, or 100% of your salary if it is lower than £40,000, attract tax relief at your marginal rate.

A pension contribution can be used to reduce the tax you pay on capital gains by boosting your higher rate threshold. Someone who earns £45,000 and who makes a taxable gain of £25,000 would pay 28% CGT, giving a bill of £7,000. But by making a gross pension contribution of £28,000, they would receive tax relief on the contribution. This means that high rate tax is only payable on income over £70,385 (£42,385 + £28,000), so the £25,000 gain is taxed at 18%, rather than 28%.

The CGT bill would fall to £4,500 – a saving of £2,500. The most that can be saved through this trick is £4,000.

Use an Investment vehicle

There are a couple pf ways to offset, or delay, paying CGT, which could reduce your overall costs. These methods are more risky because they require investment in small and often start-up companies, so are only recommended for experienced investors with a diversified portfolio.

Investors with a CGT liability might consider investing in Enterprise Investment Schemes (EIS) as they could get an income tax credit but EIS can also be used to defer a CGT liability. EIS’s offer a 30% income tax credit to investors who buy shares in small, unlisted companies. The minimum holding period is three years.

Landlords with a CGT liability could postpone the gain they have mad by investing the equivalent amount in EIS shares. Through CGT deferral relief, the liability would only recrystallize when you sell your EIS shares. In theory, high rate tax payers could defer the liability until they retire and become basic rate tax payers, or continue rolling over the liability right up until death, when EIS shares would be exempt from inheritance tax and the CGT liability would dissolve.

For more help and advice please do not hesitate to contact us at Hoskin Mortgages.

Clare Allen.

Hoskin Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority number 613005. The guidance and/or advice contained in this website is subject to UK regulatory regime and is therefore restricted to consumers based in the UK. Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.

Buy to Let – The New Tax Rules

In the 2015 Summer Budget and Autumn Statement, the Chancellor introduced several changes that will affect anyone buying or owning a buy-to-let property in the UK. It is important that landlords understand these changes because they may affect the profitability of many buy-to-let portfolios, however small or large they are.

From 1 April 2016, higher rates of Stamp Duty Land Tax (SDLT) (3% above the current rates) will be charged on the purchase of additional UK residential properties. This may impact buy to let investors. For example, a property bought now for £500,000 would attract an SDLT rate of 5% or £25,000. But after 1 April it will be 8% or £40,000 if the purchaser already owns one or more UK residential properties.

Also, from 2017 the amount that some landlords can claim in tax relief on their finance costs (such as mortgage interest payments, interest on loans to buy furnishings and fees incurred on taking out and repaying mortgages) is being gradually reduced over 4 years.

When the new restrictions are fully in force from the beginning of the 2020/21 tax year, landlords will only be able to claim tax relief at the basic tax relief of 20%, instead of 40% or 45% for those in higher or top rate income tax brackets respectively.

How the current rules work

At the moment, you can claim all of the annual mortgage interest you pay against your income from a property, and then only pay tax on the difference. So if your income tax rate is 40% then your tax bill is 40% of this difference.

Here’s an example. Let’s say your buy-to-let property generates a rental income of £10,000 a year, while you pay £9,000 interest on your annual mortgage payments. At the moment, you only pay income tax on the £1,000 difference between the rental income and the mortgage interest.

If you pay the basic rate of tax (20%), you’ll owe £200. Those who pay the higher rate of tax (40%) will owe £400, and if you pay the top tax rate of 45%, it would be £450. In another example, if you receive £15,000 in rent annually and pay mortgage interest payments of £10,000 a year, a basic-rate taxpayer will owe £1,000 under the current rules, while a higher –rate tax payer will owe £2,000 and a top rate taxpayer would owe £2,250. These examples assume there are no other deductible expenses for tax purposes.

The New Rules Explained

From 2017, the way tax relief is calculated is going to change. Under the new rules, you will owe tax at your personal tax rate on the entire income of the property. From 2020/21, when the rules are fully in force, you will only be able to deduct a maximum of 20% of your mortgage interest payments from the tax liability to calculate the amount of tax due.

This means that if you pay income tax at the basic rate of 20%, you won’t see any change in the amount you owe.

Imagine that your buy-to-let property generates an income of £10,000 a year with mortgage interest paid of £9,000. In 2020, when the new rules are introduced in full, you will be taxed at 20% of £10,000 (or £2,000). Then 20% of your £9,000 mortgage interest payments (or £1,800) can be deducted, leaving you with a tax bill of £200, the same as before.

But higher and top-rate taxpayers will pay more. Based on the same scenario, in 2020, higher-rate taxpayers will be taxed at 40% of £10,000 (or £4,000) but will only be able to deduct 20% of their £9,000 mortgage interest payments ( or £1,800).

This will leave higher-rate tax payers with a tax bill of £2,200, compared to £400 under the current system. Those paying the 45% tax rate will owe £2,700, rather than £2,250.

Wear and Tear

That’s not all that may be changing. The Chancellor has proposed that, from April 2016, you’ll only be able to claim for “wear and tear” costs actually incurred on replacing furnishings when calculating taxable profits. You’ll do so by providing itemised receipts that show the replacement goods you’ve purchased or repairs you’ve carried out. Currently, you’re given an allowance regardless of your actual expenditure.

Prospective landlords and those with existing properties may want to work out how their plans will be affected by the new rules to avoid a surprise later on. When planning, remember that just as these rules are changing now, they might do so again in the future. The effect of tax rules can change and will depend on your own circumstances.

Safety Rules are Changing

Landlords must already follow certain safety rules. These include obtaining an Energy Performance Certificate for a property before advertising it to tenants, as well as an annual gas Safety Certificate for their property’s boiler and other gas appliances. New measures include rules for preventing legionnaire’s disease and for fitting smoke and carbon monoxide alarms.

Also, the government is proposing new rules to make it more difficult for landlords to evict a tenant if the property’s appliances don’t have a current Gas Safety Certificate.

Focus on the Long Term

With changing tax rules and tighter regulations being introduced for buy-to-let landlords, it’s vital to think carefully about the type of investment you want to make. Properties can offer both asset growth through rising house prices and an income from rents- although neither of these can be guaranteed; values can fall and any rent might be exceeded by outgoings.

If you’re thinking of investing in buy-to-let, bear in mind it’s relatively high-risk and illiquid investment.

Also remember that, just as tax rules are changing now, they could change again in the future and their effect on you will depend on your circumstances – which can also change. The government is still encouraging everyone to take greater responsibility for their long term needs by “giving them more flexibility about how they spend their pension’s savings”. For many people who are looking to release funds, considering becoming a landlord is the next step.

The property on which any lending is secured may be repossessed or a receiver of rents may be appointed if you do not keep up repayments on the mortgage.

For more help and advice please do not hesiate to contact me.

Kind regards,

Clare Allen @HoskinMortgages

Hoskin Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority number 613005. The guidance and/or advice contained in this website is subject to UK regulatory regime and is therefore restricted to consumers based in the UK. Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.

The Bank of England is likely to introduce stress tests for buy-to-let mortgages, which will restrict the amount landlords can borrow, brokers have warned.

It has been suggested that the Bank might look to use other tools other than interest rate rises to control the housing market without endangering growth in the rest of the economy. The Bank of England revealed they have an FPC, which works alongside the MPC. It has tools which can put limits on the amount of indebtedness that household can take on and so can reduce the banks’ ability to lend very risky loans.

The FPC is to receive powers to temper the buy-to-let market which could suggest tougher controls on lending to landlords. While the FPC is set to gain greater control over the sector, it is still down to the committee to decide whether to use the extra powers, which have yet to be decided.

When the Chancellor confirms the FPC’s powers over the buy-to-let market, they may try to introduce the same stress test as they require for residential mortgages, which is to test affordability against a 3 per cent interest rate rise. Because rental cover requirements for buy-to-let are normal 125 per cent at a 5 per cent interest rate, the stress test would have the effect of restricting LTVs. It is quite likely that the bank will do that at some stage next year.

The bank of England would like to curb the housing market and they might do something to limit buy-to-let LTVs. If they start stress testing for a 3 per cent increase in rates that would clearly cool the market and limit borrowing, but it depends on exactly how they calculate this.

Lenders are already starting to introduce stress tests though and buy-to-let growth has been slow and sustainable, with much of the increase in lending coming as a result of landlords re-mortgaging rather than new purchases.

For more help and advice on mortgages please contact us @HoskinMortgages.

Help to Buy

Help to Buy

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