CGT on Property – Understanding the Rules for Rental Homes

When you sell a residential property that is not your main home, you may be liable to pay Capital Gains Tax on the profit you make. It is crucial that all landlords and property owners understand what this tax is and how it directly impacts the final return on your investment.

The laws governing what you owe are very complex, but this complexity is often overlooked until it has led to unexpected tax bills and rushed decisions. Hence it is important to get a proactive grasp of CGT, as it is a vital step in effective financial planning for any property portfolio.

What is Capital Gains Tax on Property?

Capital Gains Tax (CGT) is the tax levied on profit or gain you make when you sell an asset that has increased in value. In the context of residential properties, CGT applies specifically to the selling of houses that are not your main residence. These can be buy-to-let investments or second properties.

When you sell your primary home, it is usually exempt from CGT due to the Private Residence Relief. In contrast, CGT is applied when you dispose of a rental home which includes selling it, gifting it or transferring it to someone else. 

How CGT is Calculated on Rental Homes

CGT is calculated on the profit you make from selling your property, after you have deducted the original purchase price and certain allowable costs. This calculation follows a three-step process to determine the final tax owed.

First you calculate the gross gain by subtracting the original price of the property from the final sale price. This initial figure will represent the total increase in the property’s value.

Sale Price – Original Price = Total Profit

Next, you have to deduct all the allowable costs from the gross gain. Allowable costs are the ones directly associated with buying, selling or permanently improving the property. Examples of allowable costs are:

• Stamp Duty Tax paid on purchase
• Legal and estate agent fees for both sale and acquisition
• Capital improvements on the property (i.e. extension, new roof, kitchen installation)

To remember these costs at the time of sale, it is crucial that you keep all the records, as these costs will help reduce your taxable gain.

In the third step, you have to apply any available reliefs and exemption to the net gain. The most significant is your Annual CGT allowance.  This is a tax-free amount every individual in the UK receives each tax year. For the tax year of 25/26, the annual CGT allowance for all individuals is £3,000. 

After applying all the available reliefs and exemptions, the remaining gain is either taxed at 18% or 24%, depending on your income tax band. Individuals having a low income tax-band are taxed at 18% and individuals with high income tax-band are taxed at 24%

Key Rules for Rental Properties

There are certain key rules that you are required to navigate to get an accurate calculation on your CGT.

Private Residential Relief (PRR) is important to understand if you have at any time lived in the property you want to sell. In such a case, the period you have resided in that property and the final 9 months of the ownership, any gain on both these periods is deemed tax-free in PRR.

Letting Relief is a highly restricted relief for the property owners. It only applies in cases, if you have, at any time, shared occupancy with a tenant, meaning you rented out a room to an individual while living in the property. According to the current rules, Letting Relief is not available to landlords who have, in the past, rented out their home entirely. 

Reporting Deadlines and Recent Changes

HMRC has set strict reporting deadlines for all landlords and property owners. You must report the Capital Gains to HMRC and pay the estimated CGT within 60 days of the sale completion. This process is usually done through a UK property account.

This process for reporting CGT to HMRC is quite simple. You have to provide the details like sale price, property information, and gain calculation. Then, just pay the CGT HMRC’s online payment options.

Common Scenarios for Landlords

The way Capital Gains Tax is calculated, varies depending on your specific situation. Therefore, understanding how CGT is applicable to your situation is essential for accurate planning and compliance. Some common scenarios to look for are: 

1. Selling a Former Main Home

This is the most common scenario, as it concludes selling of a residential property that once used to be your home, but was later rented out. In this case, you can claim Private Resident Relief. This relief is considered extremely valuable, as it makes the final 9 months of your ownership exempt from tax, along with the proportion of the gain for the period you lived in the property. Hence, you only have to pay CGT on the gain attributed to the time, it was a let property, excluding the final 9-month period.

2. Selling a Buy-to-Let Investment

If you are selling a property that was solely purchased for the purpose of rental income, then the entire capital gain is subjected to CGT. In such cases, PRR does not shelter any of the profits, instead all the gain from selling your property is taxable after you have applied your annual CGT allowance. 

3. Joint Ownership Situations

When a residential property is jointly owned by two or more individuals, then each owner is treated as a separate taxpayer. The joint owners of the property could be, spouses, civil partners, siblings, or business partners.

The total gain after selling the property, is then split according to the legal ownership share. After this, each individual can then use their own annual CGT allowance and pay the tax applicable on their individual income tax bands. This kind of structure is considered highly profitable for tax planning.

Ways to Minimise Capital Gains Tax on Property

Tax planning in advance is an important factor in legally reducing your Capital Gains Tax bill, when selling a rental property. We have devised some effective methods that can be used to minimize your liability.

Offsetting Capital Losses:

If you have had losses from your other investments, you can deduct these losses from your property gain. This helps to reduce your overall taxable amount. You must report all your capital losses to HMRC on your tax return. This strategy is valuable as it helps review your entire investment portfolio before selling a property.

Utilising Your Annual CGT Allowance:

In the UK, every individual gets a CGT allowance (£3,000 for tax year 25/26). If you have a modest gain from selling your property and you combine your CGT allowance with your spouses, you may pay no taxes at all!

Transferring Ownership Between Spouses:

Transferring of ownership between spouses or civil partners is CGT-free. If you decide to transfer a share of your property to your spouse before the sale, then both partners can utilize their individual CGT allowances and lower-rate tax bands.

Documenting Allowable Costs:

Meticulous record-keeping can significantly reduce your taxable gain. When you keep records of all your property-related expenses, like purchase costs, investment costs and selling costs, it becomes easier for you to later on deduct the allowable expenses from your net gain at the time of selling.

Practical Tips for Property Owners

As a property owner, it is highly recommended by experts that you carefully prepare in advance on how to manage your Capital Gains Tax. We’ve consulted with our accountants to bring you these practical key steps:

• Maintain Meticulous Records: Keep all purchase documents, retain records of selling costs, and file your invoices for capital improvements timely.
• Plan Well in Advance: It is always helpful to review your tax position at least 12 months before the intent to sell, and calculate your potential gains and liabilities proactively.  Also, explore ownership restricting opportunities for your property and how they can be used to minimise CGT.
• Seek Professional Advice: It has never hurt to consult a property tax specialist before making any important selling decisions. Experts can help you apply the correct relief to your situation while ensuring the 60-day reporting rules.
• Understand Allowable Costs: You should be able to distinguish between allowable costs and other costs so you can keep separate records for both and claim only the eligible costs.
• Regular Portfolio Reviews: Conducting annual assessments of your property investments and monitoring the changes in tax legislations will enable you to adjust your selling/buying strategies based on correct market conditions. 

Conclusion

Understanding Capital Gains tax on rental properties is critical for protecting your investment returns. With this guide, we can help provide a solid understanding of CGT, but every landlord’s situation is unique, hence we strongly encourage you to seek professional tax advice from our experts at Heighten Accountants. 

With our guidance, and step-by-step planning, you will be able to maximise all available reliefs and meet all the compliance requirements. 

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