Update 30 October 2024 – Following the Budget announcement today, some of the details mentioned in this insight may have changed. Please visit our Budget page for further information.
What do the new rules mean for landlords?
In July the Government published its draft Finance bill for 2019-20. It includes changes to a few important aspects of Capital Gains Tax (CGT), specifically in relation to principal private residence relief (PPR) and lettings relief.
The new rules were first proposed in the 2018 Budget, and following their introduction to Parliament – after the forthcoming autumn Budget – are expected to receive Royal Assent in spring 2020 and come into effect at the start of the next tax year on 6 April 2020.
What changes are being introduced?
The government’s plan is to:
- Reduce the deemed ‘occupation period’ allowable under Principle Private Residence (PPR) relief at the start of the next tax year; and
- Remove lettings relief completely, unless the owner has shared the property with a tenant.
In a nutshell, what it means is that if you sell a property (and especially if you own more than one property), you may well need to pay more Capital Gains Tax (CGT).
1. Changes to Private Residence Relief (PPR)
PPR is a relief from Capital Gains Tax (CGT) on the sale of an individual’s main home. And if you’ve lived in your home for the entire period that you’ve owned it, with no tenants, then any capital gain that results when you sell it is exempt from CGT. That much is clear, and no changes are being proposed there. So far, so good.
However, if you sell a property that has been your main home for only part of the period of ownership – for example, if you have ever rented it out – things are not so simple.
Under the current rules (i.e. for the 2019-20 tax year), you’ll still receive some PPR relief for the period during which the property has been your main home. And regardless of how long that period lasted, the last 18 months of ownership are always deemed to be a period of qualifying occupation for purposes of the PPR relief.
The rule changes propose that this period will be cut from 18 to the last nine months of ownership for a property sale that occurs after 6 April 2020.
The reduction means that from 6 April next year, anyone buying a new home, before selling their old one, will need to ensure a sale of the old property takes place within nine months to avoid a potential CGT charge.
There will be no change for disabled people or those who are selling in order to move into a care home. In these situations, the last 36 months will remain exempt.
2. Changes to Lettings Relief
Lettings relief applies where someone sells a property that has both been their main home and which has also been let out for a time during the period of ownership.
Currently, in such a situation, lettings relief means that up to £40,000 of any gain on a property sale is tax-exempt. With an assumed CGT rate of 28%, lettings relief can therefore reduce your tax bill by up to £11,200 (28% of £40,000). Lettings relief applies per owner rather than per property too.
Under the new rules, from 6 April 2020, lettings relief will only apply in situations where the owner of the property is in shared occupancy with the tenant. In other words, living together, under the same roof.
What does it mean in practice?
As a result of the new rules, any lettings relief (currently worth up to £11,200 of CGT), will be lost unless the property seller also lived in the home at the time it was let out.
Here’s an example of how the rule changes will work:
Mrs Jones has lived in her house for 5 out of 10 years. She met a new partner and moved in with him, and rented out her house in the meantime.
After 10 years of owning the house she decided to sell it, making a capital gain of £150,000.
Under the Current Rules
Under the current rules, Mrs Jones receives PPR relief for the five years she lived in the house, plus the last 18 months. So the PPR relief applies to so six and a half years in total, or 65% of the period of ownership, leading to 65% of the £150,000 gain being exempt from CGT.
Therefore, Mrs Jones won’t pay tax on £97,500 of the gain (being £150,000 x 0.65). The remaining 35% (£52,500) gain is not covered by PPR and this represents her taxable gain.
Under the current rules, lettings relief is applicable to the remainder, and Mrs Jones can claim a valuable £40,000 in lettings relief.
That means she will pay CGT on the £12,500 remaining from the capital gain, resulting in a CGT tax bill of £3,500 (assuming a 28% CGT rate and also assuming that she has used her capital gains annual exemption elsewhere).
Under the New Rules
After 6 April 2020 the calculation looks very different. The £97,500 tax-exempt figure above now falls to £86,250 (£150,000 x 0.575), representing the five years and final exempt nine months (instead of 18 months before).
This leads to a higher chargeable gain of £63,750 (£150,000 – £86,250).
More significantly, no lettings relief is available in this example. That means Mrs Jones will incur a CGT bill of £17,850 (£63,750 x 0.28, again assuming the gain is taxed at 28%).
So the net effect of the new rules mean that Mrs Jones’s tax bill has risen from £3,500 to £17,850, an increase of £14,350 or 510%!
The Final Word
The changes to PPR and lettings relief have been criticised by some as being a further cash grab on landlords by HMRC, following other moves in recent years such as stamp duty increases and restrictions on mortgage interest relief.
Government estimates suggest the two changes will generate an additional £470m in tax revenue for HMRC over the next four years.
If you have a former home that has been let for a number of years AND you are thinking of selling it or gifting it (eithers into Trust), you need to consider the tax implications of a pre or post 6 April 2020 disposal – remember for CGT purposes the disposal date is the date the deal becomes contractual/unconditional.
If you would like advice on how these changes might affect you, don’t hesitate to get in touch with Debbie Wilson on debbie.wilson@hhllp.co.uk or 02079307797 and she’ll be happy to help.
