Springtime is traditionally peak house buying season and by this time of year it is in full flow. This blog aims to help those who are either buying or selling residential property by clarifying the current tax position when a residential property (classified as a dwelling house by HMRC) is sold.
Property taxes have been subject to major reforms in recent Budgets and this article brings together a number of issues to highlight what taxes sellers (and buyers) can expect if their property has been rented for a period, or if they own multiple properties.
New rates of capital gains tax
Capital gains tax was reduced in the March 2016 Budget and the new rates (20% for higher rate tax payers and 10% for basic rate tax payers) became effective from 6th April 2016. These reduced rates do not however extend to residential property sales; chargeable gains arising on the sale of residential property, most usually buy to let or second homes, will continue to attract capital gains tax at the previous rates of either 28%, or 18% where they fall within the seller’s basic rate tax band.
Qualifying for PPR
Capital gains tax is not payable if the property sold was a main dwelling house (i.e. a house/flat/houseboat/static caravan) which was the owners’ principal private residence (PPR) for the entire period of ownership. This is the case unless certain conditions apply as follows:
- There was an unoccupied period of ownership which was not work related;
- Part of the property has been exclusively used for a business activity;
- The dwelling building is sold separately to its garden area or outbuildings (if applicable); or
- The property was purchased and renovated within a short time period purely to make a gain.
Extended reliefs
Where PPR relief is available but the property has not been the owner’s PPR throughout the entire period of ownership, the last 18 months’ of ownership will still qualify for the PPR exemption, irrespective of how the property was used in that 18-month period, for example even if it was empty or rented out.
In addition to this extended PPR exemption, lettings relief is available where a property has been the owners’ PPR and has also been rented out. This relief is a maximum of £40,000 per owner, restricted to the amount of the PPR exemption.
With the benefit of these extended reliefs and the annual capital gains tax exemption (currently £11,100 per individual), it is possible to continue to own a previous PPR for quite a significant amount of time before incurring a CGT liability on its sale.
Extended periods of ownership
Given ongoing competitive property market conditions in the London and south east areas, it is not uncommon for a seller wishing to purchase a new home to proceed with a new property purchase before they have sold their former home. If they have difficulty in selling the former home, they may make a decision to rent it out for a while, especially given the extended CGT reliefs available. In this instance, increases in stamp duty land tax (SDLT) also need to be taken into consideration.
Capital Gains position
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Selling the family home within 18 months of moving out
For capital gains tax purposes, this is quite a clear-cut position; if you sell the family home within 18 months of moving out, you will be able to claim the extended PPR exemption which will exempt the gains arising in that period from CGT.
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Calculating gains beyond the PPR and extended PPR period
If the first property is sold outside of the 18-month timeframe, PPR relief is applied on a time apportionment basis to the qualifying period of occupation and the last 18 months.
Any lettings relief due is then applied to the time apportioned gain which arises outside this exempt period, with the annual CGT exemption being applied to the balance.
Example illustrating how CGT is calculated on a second property
Mr and Mrs Smith bought a house in June 2004 and sold it in December 2015, jointly owning it for eleven and a half years.
The family lived in the property as their only or main residence from June 2004 to December 2011 (seven and a half years).
It was then let as residential accommodation from January 2012 to December 2015 (four years) until it was sold at a final gain of £550,000.
Mr and Mrs Smith are entitled to PPR relief for nine years (based on their seven and a half years of residence plus the final 18 months) out of eleven and a half years.
This part of the gain is £430,435 (£550,000 x 9/11½), which leaves a remaining gain of £119,565.
They also qualify for lettings relief of £80,000 (£40,000 x 2) because this does not exceed the PPR relief.
Because they have not used their annual CGT allowance (£11,100 per person x 2), they can also offset a further £22,200 against the taxable gains.
This equates to an additional £102,200 of tax relief to offset against the gain, leaving a final taxable gain of £119,565 – £102,200 = £17,365
Mr Smith and Mrs Smith owned a 50:50 share of the property and their CGT is calculated as follows:
Mr Smith’s portion as a higher rate tax payer = £8,682 * 28% = £2,431.10
Mrs Smith’s portion as a basic rate tax payer = £8,682 * 18% = £1,562.76
Total CGT payable on property sale = £3,993.86
SDLT position
New rules and impact of stamp duty surcharge
As outlined above, it is possible to claim PPR relief on the former home and not pay capital gains tax on the eventual sale, provided the disposal occurs within 18 months of purchasing the new home.
However, if new property is purchased before the former PPR is sold, revised rules relating to increased stamp duty (SDLT) will apply to the second property. From 1 April 2016, anyone buying additional residential property is required to pay a 3% stamp duty surcharge on top of the original tiered stamp duty rates. This is payable in full, immediately upon completion of the sale.
Financially, this means that a buyer purchasing a second property for £900,000 will pay stamp duty as follows:
Charge at basic SDLT rates:
(250,000 – 125,000) @ 2% = £2,500
(900,000 – 250,000) @ 5% = £32,500
Total charge base £35,000
Additional SDLT supplement:
900,000 @ 3% = £27,000
Total SDLT payable = £62,000
Increase in SDLT = £27,000
Our earlier blog on this topic explains the new stamp duty rates in more detail.
Potential to reclaim stamp duty paid
If a sale is completed on the original property within 18 months of purchase of the second property, the additional 3% stamp duty paid can be reclaimed from HMRC in full. So on the above example, the additional SDLT paid of £27,000 would be recoverable.
If however the first property continues to be owned beyond the 18-month period, so that two properties are owned for 18 months, the additional SDLT paid cannot be reclaimed. This additional cost must therefore be factored into the overall calculations when deciding whether to sell property or hold onto it for the longer term.
If you would like to discuss the impact of property taxes on a proposed sale or purchase, please contact Lesley Stalker by emailing las@rjp.co.uk.