By Simon Misiewicz Article relevant to the tax year 2020-21
Reduce Capital Gains Tax when Selling Property Investments
Common Capital Gains Tax questions when selling a residential property investment
In this article we are going to answer the following:
- What are your capital gains tax annual allowances?
- How you can use delayed completions to utilise your annual capital gains tax allowances?
- What is the capital gain tax on the sale of a residential property?
- Is capital gains tax payable on the gift of property?
- How long do you have to live in a property to avoid capital gains tax?
- How do I avoid paying capital gains tax on property?
- What percentage is capital gains tax on property?
- Is there a capital gains tax calculator?
- Can I gift my property investment to my children?
- How do I legally reduce capital gains tax on property disposals?
- Does someone selling a second home have to pay CGT?
Before we jump into the detail of how we reduce Capital Gains Tax we first need to understand the basics. Visit the article where we describe what the Capital Gains Tax allowances are. We will also go into the details behind the Capital Gains Tax rates that are applied once the annual allowances are exceeded.
You will typically pay Capital Gains Tax when you sell a residential buy to let property.
Capital Gains Tax changes in 2021 – What To Expect?
In July 2021 Rishi Sunak the chancellor of the exchequer requested the Office of Tax Simplification (OTS) a review of the capital gains tax system. It is fair to say that the Capital Gains Tax review – first report: Simplifying by design proposes a number of changes to the current Capital Gains Tax system.
How To Avoid Capital Gains Tax – When Does This Happen?
You do not usually have a Capital Gains Tax bill in the following circumstances
– Gifts between husbands and wives
– Transfer of assets between civil partners
– Donations made to a charity
– If you have Capital Gains Tax losses brought forward from previous years
Capital Gains Tax Applies Upon the Agreement of Sale – Delayed Completions
There may be times when people agree to sell a property sometime in the future. Capital Gains Tax applies upon the agreement of sale rather than when the sale took place.
Residential Property Investment – Transferring to a Limited Company
Landlords may wish to transfer an investment property to a limited company. The mortgage interest may be offset in its entirety within a limited company. There are a few considerations before you sell your residential property to a Limited Company:
- Stamp Duty Land Tax (SDLT) will be chargeable on any deemed land transaction. Please do not forget that there is also a 3% additional SDLT charge on the full amount of the property. This applies where the value of a property is £40,000 or more. I have written an article on SDLT transfers to a Limited Company
- Capital Gains Tax: You will also need to pay CGT if you transfer a property investment into a limited company. This is assuming that the property is not your trade business. Putting an investment property into a Limited Company can be a costly exercise. CGT will also be a tax liability if you transfer properties from a partnership into a Limited Company.
- Mortgage and finance: you will not be able to transfer the mortgage into the Limited Company.
Download your buy to let tax guide here, written by our property accountants
Capital Gains Tax when transferring a buy to let property to a child
Parents may wish to transfer a buy to let or second home to their children. This can be done but they need to be aware that a Capital Gains Tax bill is likely to arise. The Capital Gain will be based on the market value less the purchase price and capitalised items. You will note the words market value. This is to prevent a parent from transferring an asset for less than it is worth.
We have written a separate article for UK landlords wishing to mitigate tax when transferring a property into trust for children. The types of tax avoided are Capital Gains Tax and Stamp Duty Land Tax.
Capital Gains Tax Calculator – £9.95
This CGT calculator will tell you how much is to pay and how to reduce it further.
Buy property from family members
Similarly to the previous section, may be tax implications when you buy a property from family members. The person buying the property may have to pay Stamp Duty Land Tax (SDLT). The seller may have to pay the CGT bill on the disposal. Given that this article is about CGT we will keep our focus here.
I appreciate the article says “may have to”. Let me clarify. If you are a connected person then the CGT bill will be based on the market value of the property and the original purchase price. A connected person is one of many.
- relatives (brothers, sisters and spouses or civil partners of relatives)
Section 286 TCGA 1992 identifies persons with whom we are “connected” for CGT purposes. A taxpayer is connected with his or her spouse. Remember that the term spouse includes a civil partner. A taxpayer is also connected with his “relatives”. “Relatives” include ancestors such as one’s parents or grandparents.
Relatives also include lineal descendants such as children or grandchildren, and one’s brothers or sisters. TCGA 1992, s.286 A taxpayer is also connected with any relatives of his spouse.
These include one’s brothers-in-law or sisters-in-law, they being the brothers or sisters of one’s spouse. Relatives of one’s spouse also include one’s mother-in-law or father-in-law, so these people are also treated as connected persons. Finally a taxpayer is connected with spouses of his relatives.
An example of a son that wishes to buy a property from his father in law
John is the stepfather to Andrew and has moved into the family home with Andrew’s mum. Andrew wishes to buy the property from John, which they agree to transfer the property as a gift. We will ignore the seven-year inheritance tax rules for the purpose of this article.
John values the property as £200,000. He is pleasantly surprised as the property was purchased for £100,000 just ten years earlier. There is a mortgage of £90,000. Al John wants to do is have a nice holiday and pay off the mortgage. They agree on a price of £100,000.
On the face of it, you would assume that there is no CGT to pay by Andrew buying a property from John. This is because the sales price for John is £100,000 and the original purchase price is also £100,000. No gain no less.
Sadly they are close relatives and HMRC will require that the CGT bill computation is
£200,000 Market Value of the property
£100,000 Original purchase price
It is the £100,000 gain that will be considered as part of John’s self assessment CGT return. xxx
Top Property Key Performance Indicators for UK landlords
There are ways of ensuring that you treat your properties as a business. I firmly believe if you use these measures, you could buy fewer properties and yield better results.
Welcome to the Optimise world of property Key Performance Indicators. Here are the five measures that I believe are the most important to ensure that you make more money on your property portfolio. Note that there is not one shred of information about tax.
• Return On Investment (ROI)
• Rent Yield
• Interest Cover
• Maintenance % of rental income
• Voids % of rental income
Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read more on Buy To Let Tax Tips (opens in a new tab)
Return On Investment or (ROI)
ROI is my preferred measure. It takes into consideration the amount of profit that you make against the amount that you have personally had to invest in the property.
Let us say that you make £2,000 profit from your property and you invested £20,000. You can see that £2,000 divided by £20,000 is 10% ROI.
It is not the easiest measure because you need to understand the actual profits on a rolling 12-month basis. You can use this measure to review a) how your existing properties are doing and b) set a minimum ROI based on current performance.
For more details see the URL (1) in references.
Rent yield is a measure that compares the annual rental income (fewer bills if you run an HMO) against the purchase price. For example, you know that a property will give you £500 net rent per month and you will have an income of £6,000. If the house cost is £100,000 then you have a rent yield of 6%.
This is a “quick and dirty” measure and should not be the main part of your due diligence process. That said it is an easy way to understand if one property is worth looking at in more detail than another.
I use a benchmark of 10%+ rental yield (else I will not look at it). The downsides of this formula is that it is not ROI and is not comparing the amount of money that you need to invest in the property, such as a large refurbishment project. However, I would assume that the purchase price does take into consideration the condition it is in.
Interest cover is the profit (adding back the mortgage interest) divided by the mortgage interest itself. Even for me, reading this statement would lead my imagination to burn itself out.
£6,000 rental income
£3,000 profit before mortgage interest
£2,000 mortgage interest
In this example, we can see that dividing the profit before interest by the mortgage interest gives us 1.5:1 ratio.
£3,000 profit before interest
£2,000 mortgage interest
This shows that interest can go up by another 50% before this property becomes a loss maker. This is a key measure because as we know mortgage interest charges increase and decrease over time. Which way do you think mortgage interest rates will go? How will the effect your profitability?
I use a ratio of 2:1. This means that mortgage interest charges would need to increase by twice the amount before I start to lose money. If interest rates are at circa 5% and some of us are old enough to remember the 1980s when mortgage interest charges were in double digits.
Download your buy to let tax guide here, written by our property accountants
Maintenance % of rental income
A lot of property investor clients carry out some sort of due diligence. It is not surprising that there is a variation of % of what they think will be maintenance cost of rental income.
The main cause of this variation is down to:
• Property type
• Tennant types (demographics)
• Quality of refurbishment and furniture put into a property
I believe that HMOs with students will cost more money than a middle-aged family. I am going to generalise here and I suspect that people will have different views. That is OK with me.
Students are generally less careful and often take a little less pride in their environment especially when it is shared and they see it as a short term base until next semester. Therefore their attention to bags being scrapped along the walls, food trod into the carpets, broken kitchen doors as they are slammed in a drunkard state is usually going to be minimal.
The result of this is more maintenance costs each year. Clearly, there will be more revenue from students but I suspect that because they live in the property for just one year that the maintenance work is going to be a little more frequent than LHA tenants that live in the property for a longer time.
Rubbish in rubbish out. If the standard of the property was of poor standard then people living there will treat it as such. They may be less careful of closing the doors on a kitchen cabinet. Given the carcass and doors are cheap then there is more chance of these needing repair. The same applies to cheap shower cubicles and living room furnishings.
Buying cheap is good for now but can cost you a lot more money in the future. Invest wisely and ensure that products have warranties that can be easily managed. Do not buy warranties where a cooker needs to be sent back for three weeks. This is a waste and you would be better placed to buy a new one.
Voids % of income
If you have a property that is empty then you have a void. If you have voids then you have less rental income and ultimately less profit.
The issue with this ratio is that it is easy to calculate for due diligence (a lot of property investors we do work for use 10% to 15%) but it is less easy to do when the property is up and running, or is it?
I find that it is easy because I compare the amount of money I should have received against the money I actually received. If I wanted £6,000 rent but only got £5,000 I know that I am £1,000 short of the £5,000.
£6,000 predicted rent
This gives me a ratio of 01.67 or 16.7%. This is a lot of voids and should be managed. To find out more about what causes voids and what can be done about it please read the blog referenced.
A conclusion to Key Performance Indicators for property investors
We have provided just a small sample of what Key Performance Indicators you can use as a UK landlord. There may be others that you are more used to or thought of whilst reading this article. I am a firm believer that we are all different. This means that one Kep Performance Indicator will not be the same for everyone. It is important to establish a set of property Key Performance Indicators that will work for you.
What you focus on is what you get. This means you will need to review your Key Performance Indicators at least once a month. I would always suggest that you review your property Key Performance indicators on a weekly basis if possible to help you keep focused.