Changes to residence relief and letting relief

In a recent blog we highlighted how the Government is trying to crack down on tax relief for buy-to-let landlords. Now we consider how the proposed new property tax changes regarding residence relief and letting relief will affect some property owners.

If you sell a property that is not your main residence you may have to pay capital gains tax (CGT). For example, if you bought a buy-to-let property for £100,000 and sold it for £200,000, you would have to pay tax on the £100,000 gain.

The first £12,000 of gains made in a tax year are exempt from tax, but after that, a basic-rate taxpayer pays tax at a rate of 18% on the gain. A higher-rate taxpayer pays tax at a rate of 28% on the gain.

The sale of your main residence will likely be covered by a relief known as private residence relief (PRR) and, so long as you have lived in the property for the entire period of ownership, any gain made should be tax free.

Who will the change affect?

The proposed change will affect those who have lived in a property, at some point as their main home, but not for the full duration of ownership. (An example of where this may arise is where someone moves in with a partner and decides to retain their own property and let this out whilst the relationship develops.)

Under current rules, they would be able to claim private residence relief for the period of occupation and a secondary relief, known as letting relief, could be claimed for the period when the property was let. Letting relief can provide an exemption of up to £40,000 per person.

Example under the current rules

Mrs Lambert* has owned a property for 10 years. She lived in the property for the first four years of ownership but moved in with a partner at the end of year four. She has now decided to sell and is expecting to make a gain of £100,000. Currently, she gets private residence relief for four years of ownership plus a complimentary 18 month period that HMRC allow in respect of the final period of ownership (i.e. five and a half years of the ten year ownership period), resulting in 55% of gains being exempt from CGT. Therefore, Mrs Lambert won’t pay tax on £55,000 of the gain. The remaining £45,000 gain is not covered by PRR and this represents the chargeable gain. At this point, under current rules, letting relief is applicable to the remainder and will reduce the chargeable gain down to £5,000, resulting in a tax bill of £1,400 (assuming gains are taxed at 28% and she has used her capital gains annual exemption elsewhere).

What is changing?

HMRC are currently undertaking a consultation with regard to some proposed changes, so at this point the below is not intended to be a comprehensive statement of the law or represent specific tax advice, but as you will see, the proposed new change will potentially have a big impact.

Starting from April 2020, it is proposed that letting relief will only apply where the owner is in shared occupancy of the home with the tenant. The complimentary 18 months that HMRC allow is also being reduced to just nine months for the majority of people.

The result is that for a disposal occurring post April 2020, Mrs Lambert’s CGT calculation changes. The £55,000 exemption figure above falls to £47,500. More importantly, no letting relief will be available as Mrs Lambert was not living in the house with the tenant whilst they let it from her. This means Mrs Lambert will now incur a CGT bill of £14,700 on sale (assuming all of her gain was taxed at 28% and, again, assuming she has used her capital gains annual exemption elsewhere).

This represents an increased tax bill of £13,300 for Mrs Lambert.

When the changes receive assent from the Government I will update you, but in the meantime, watch out for my next blog, which explains the upcoming changes to the payment of CGT. Mrs Lambert may be required to pay that £14,700 of tax sooner than she thinks!

Should you have any questions about the changes and how they might affect a future planned disposal then please speak to your usual Larking Gowen contact. Call 0330 024 0888 or email enquiry@larking-gowen.co.uk

* Names have been changed