Section 24 & Capital Gains Tax implications facing landlords

In this post, RITA4Rent, in collaboration with Bamboo Auctions, explore the Capital Gains Tax implications on selling your investment property, should Section 24 result in property investment no longer being viable.  If you want to sell your property, have you considered using an online auction?

Bamboo Auctions is an online property auction marketplace. They partner up with auctioneers and estate agents across the UK to provide an efficient way of selling property. Online auctions give you flexibility (you can even sell with tenant in situ) to choose the auction period and date of exchange. There is no restriction such as needing to meet a specific catalogue date. For more information of how selling via an online property auction works please visit Bamboo Auctions by clicking here. 

Section 24 has been the hot topic in recent times. Some landlords remain unaffected, some can adapt their circumstances to mitigate the changes, whereas others simply want to exit as the figures no longer stack up. Those looking at an exit route may however be faced with Capital Gains Tax on sale of their property, and this feature explored the implications in greater detail.

To recap initially, on 6th April 2017, the Section 24 four year equal phase-in began. When the rules are fully in force in 2020, mortgage interest will no longer be deductible when calculating your rental profits. The Section 24 rules apply to those letting residential property, and so you will not be affected if you operate a Furnished Holiday Let, or a commercial lettings business. The reason these types of properties are not caught by the Section 24 rules is because this activity is classed as a “trade,” whereas the Government are attacking the so called property “investment” target. As an aside, the changes will not affect those with property in a limited company, but will affect Limited Liability Partnerships as well as unincorporated partnerships.

As a very brief illustration of how the position will be in 2020, we shall use a landlord named Mrs Smith as an example. She has rental income of £90,000, repairs, insurance and management costs of £30,000 and mortgage interest of £50,000.

Under the old rules her profit would be £10,000 but once the new rules are fully phased in, her profit will be £60,000. Under the new rules, the above profit will be taxed at her income tax rates. From there, a “reducer” is applied to the tax owed as calculated above, which is typically 20% multiplied by the mortgage interest paid.

To confirm, we use the word “typically” above, as strictly, the tax “reducer” is calculated as the 20% of the lower of:

• Total mortgage interest and finance costs which have not been deducted from income

• Total profits less any losses brought forward

• Total income (minus savings/dividend income) which exceeds the personal allowance

However, the above is the position in 2020, whereas at present, tax returns need to be completed for the first year of the phase-in i.e the 2017/18 tax year. Year by year of the phase in, the amount of mortgage interest which may be claimed on your self assessment tax return is:

• 75% for the 2017/18 Tax Year

• 50% for the 2018/19 Tax Year

• 25% for the 2019/20 Tax Year

• 0% from 2020/21 Tax Year onwards

We shall be exploring the tax position of a landlord we shall refer to as Mrs Maureen Jones, ascertaining the Capital Gains Tax (CGT) due, and the full workings are shown on Bamboo’s blog by clicking here.

Maureen decided that Section 24 made her property investment no longer viable, and sold her sole property.

Maureen is a full-time employee, a higher rate taxpayer earning £50,000 per annum (with £8,700 PAYE deducted at source using a standard tax code). The only other income she received was from the property, which she owned solely.

Maureen sold her property on 1st March 2018. This sale therefore relates to the 2017/18 tax year. She received no other rental income in that tax year as the property was empty as she prepared it for sale.

She originally purchased the property for £200,000, and incurred £10,000 in purchase costs, such as solicitor’s fees and initial capital improvement costs. After completing, she lived in the property as her main residence for 6 years.

Following her marriage, she decided to move into her husband’s home, and began letting the property, and the property was let for 7 years before the property was sold.

During the period of ownership, a further £15,000 of improvements were carried out.

The property was sold on 6 April 2016 for £350,000, and Maureen incurred estate agent commission and other selling costs of £5,000.

The full calculations are on Bamboo’s blog, which show that no Capital Gains Tax falls due.

With reference to the calculations on Bamboo’s blog, Maureen’s capital gain is covered by the £11,700 annual CGT allowance, and so no Capital Gains Tax falls due.

With reference to the above, the gross gain before reliefs is £120,000. However, this can be reduced by PPR and Lettings Relief. First of all, for PPR, Maureen lived in the property for 72 months, and the last 18 months of her ownership can be added this, meaning 90 months out of the total ownership period of 156 months qualify for PPR relief. Letting relief is available when:

• You sell an investment property which is, or has been, your only or main residence, and

• Part or all of the above property has at some time in your period of ownership been let as residential accommodation.

The relief which is available to reduce your capital gain, is subject to a 3 point test. The value to use is the lowest of the following:

• The amount of any chargeable gain you make because of the letting (calculated as a fraction of the gain – the fraction being the period of letting/divided by the period of ownership).

• The amount of Private Residence Relief already calculated.

• £40,000.

Therefore, with reference to the above and the calculations, £40,000 is available for relief here. We are then left with a chargeable gain of £10,769. The annual CGT allowance of £11,700 may be used to eliminate this, meaning there is no taxable gain.

But what would have happened, had Maureen never lived in the property, and simply purchased the property to let to tenants, whilst living in a different property?!

Section 24 and Capital Gains Tax Illustration 1

As the illustration above shows, Maureen would not benefit from PPR nor Lettings relief, meaning that her chargeable gain is £120,000, with the only allowance available being the £11,700 annual CGT allowance. Therefore, Maureen will be faced with a substantial tax bill when filling in her self assessment tax return. To illustrate this, we shall look at Maureen’s full tax calculation for the 2017/18 tax year:

Section 24 and Capital Gains Tax Illustration 2

With reference to the above, Capital Gains tax is payable on the chargeable gain of £120,000 MINUS the £11,700 annual CGT allowance, which gives £108,700. Given Maureen’s higher rate earnings bracket, all the gain is taxed at 28% meaning a total tax bill of £30,436.

The CGT regime is extremely complex, and these basic examples are just scratching the surface. As such, if you are looking at selling a property, tax advice is strongly recommended.

Here at RITA4Rent, we can even provide an appraisal prior putting your property on the market, to ensure you are fully aware of any likely tax owing, and also, to see if there is anything that can be done to mitigate your tax bill.

For any of your property tax needs, please do not hesitate to contact RITA4Rent on Freephone 0800 1 22 33 57 or via email by clicking here.