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If you sold a property before 6th April 2020, and rented out the property for part of the period of your ownership, then it is likely you were eligible for private letting relief.
What is Private Letting relief?
HMRC state that the private letting relief can be used where
- you sell a dwelling house which is, or has been, your only or main residence, and
- part or all of it has at some time in your period of ownership been let as a residential accommodation.
The amount of private letting relief that can be claimed cannot be greater than £40,000, and it must be the lowest of the following three values:
- £40,000;
- the amount of private residence relief that has already been claimed;
- the amount of any chargeable gain that is made due to the letting; that is, this is the amount that is attributed to the increase in the property value during the period it was let.
The use of this relief is best illustrated via the following case study.
Private Letting Relief Case Study
Roger buys a house for £50,000 on 6 April 2012.
He lives in the house for two and a half years and then decides to move to another house. He rents out the first house for the next five and a half years.
On 5 April 2020 he exchanges contracts and sells the house for £130,000. This means that he has made a capital gain of £80,000. The capital gain of £80,000 spread over 8 years equates to a gain of £10,000 per year.
The first two and a half years are exempt from CGT since he actually occupied the house as his main residence. The last year and a half are exempt from CGT due to the final period exemption – deemed occupied. This makes a total principal private residence relief of £25,000 + £15,000 = £40,000.
This means that he is only liable to pay CGT on the remaining £40,000 of chargeable gain. However, Roger is also able to claim private letting relief, and the amount he can claim is the lowest of the following three values:
- £40,000;
- amount of private residence relief already claimed is £40,000;
- amount of any chargeable gain that is made due to the letting is £40,000.
This means that Roger is allowed to claim private letting relief of £40,000 as this is the lowest of the three values (obviously).
Therefore, the outstanding chargeable gain of £40,000 is cancelled out by this relief, which means that he has absolutely no CGT liability.
In other words, Roger has made a tax-free capital gain of £80,000 just by having lived in a property for two and a half years!
The Abolishment Of Private Lettings Relief – April 6th 2020
For some already reeling from the restriction on mortgage interest tax relief and additional rates of stamp duty land tax, the government’s proposed abolition of lettings relief, as well as a reduction in principal private residence (PPR) relief, was viewed as the final straw.
The taxpayers most affected by the changes will be those dubbed ‘accidental landlords’. These are broadly individuals who have rented their properties out of necessity; for example, a contractor who has let out their home when a job required them to move abroad for a year; or a divorcee who has rented out a previously shared property after a separation. In these cases, any increase in the value of their home will most likely incur a greater capital gains tax (CGT) bill if the sale of the property takes place after 5 April 2020.
Restricted Private Letting Relief
The reduction in lettings relief is the main reason for this increased tax bill. At present, lettings relief provides up to £40,000 of relief (£80,000 for a couple) to landlords who let out a property that is – or previously was – their main residence.
From April 2020, lettings relief will apply only where the owner is sharing occupancy of the home with a tenant. For some higher rate taxpayers, this additional tax charge of up to £11,200 (£40,000 at 28%) changes the playing field considerably. If a property has been let to tenants, the owner will have to pay CGT on their taxable gain after the sale is made. The tax liability will fluctuate depending on how long they lived in the property. Landlords are presently able to take advantage of PPR relief, meaning that they are not required to pay any CGT for the proportion of years in which their rental property was their main residence. The chargeable gain is therefore directly correlated to the number of years spent living within the property.
From Bad To Worse for Letting Relief…
In addition to this, landlords were granted an extra exemption for the last 18 months of ownership, even if they did not actually reside at the property during this time. However, from April 2020 this exemption will be reduced to nine months. For less expensive homes, the effect of this is smaller when compared to the loss of lettings relief, but it will certainly affect those who have only recently begun to rent their property (i.e. under 18 months).
The combined loss of lettings relief and the reduction to PPR relief will be felt by many, to varying degrees. While it is difficult to represent the effect this will have in each individual case by way of example, we can compare a sale made in the present day to one made in the future.
Private Letting Relief And Sale Of Former Private Residence Case Study
Selling Before 6th April 2020
A landlord makes a sale of a property which they had owned for 12 years; their total gain on the sale is £120,000 (Note: each individual has a tax-free capital gains allowance of £12,000, but for the purposes of this example we’re assuming this has already been utilised elsewhere).
Let’s say the landlord had lived in the property for the first six years, only letting it out for the remaining years. As the home was their private residence for the first 50% of ownership, they would be eligible to take advantage of PPR relief. They are also able to claim PPR relief for the last 18 months of ownership. This subtracts a total of seven and a half years (62.5%) from their 12-year ownership, and as a result, they will not pay tax on £75,000 of the total gain. The remaining 37.5% (i.e. £45,000) of their total gain is not covered by PPR relief and so this would be the taxable gain.
Up until 5th April 2020, the seller is eligible to claim a further £40,000 of lettings relief on this. This has the effect of further reducing the taxable gain to a mere £5,000.
If the seller was a basic rate taxpayer, they would pay CGT on residential property at a rate of 18%, leaving them with a CGT liability of only £900. For a higher-rate taxpayer, the CGT rate on residential property rises to 28% but still, their total gain of £120,000 has accrued a mere £1,400 tax bill.
Selling From 6th April 2020 Onwards
From 6 April 2020, the same property transaction would incur an increased tax liability. The landlord would be able to claim PPR relief for the first six years of ownership but only an additional nine months, reduced from the eighteen previously. This subtracts a total of six years and nine months (56%) from their 12-year ownership and as a result, they will not pay tax on £67,500 of the total gain. The remaining 43.8% (i.e. £52,500) of the taxable gain is not covered by PPR relief and so this would be the new taxable gain.
In this example, it makes a marginal difference when compared to the loss of £40,000 in claimable lettings relief. As there would be no further tax relief to take advantage of, our landlord would be left with this chargeable gain of £52,560, rather than the £5,000 in the present-day example. Our higher-rate income taxpayer, paying CGT at 28% on the full amount of the gain, would see their tax bill rise to a total of £14,700; a 1050% increase.
Of course, the benefits of lettings relief are felt most strongly on smaller gains around the £40,000 mark (£80,000 for couples). Assuming no upgrades or refurbishments are made to the property, a total gain of £120,000 would usually only be accrued through long-term ownership. Therefore, it will be newer landlords who will end up paying more tax than anticipated as a result of the removal of lettings relief.
As the abolition of lettings relief does not affect landlords who have never lived in their property or owner-occupiers, the effects of the changes to lettings relief and PPR relief will be felt by newer landlords and those who may have had no choice but to rent their homes in order to keep them.
