A buy-to-let property has a range of benefits, including regular income in the form of monthly rent and long-term appreciation if it grows in value over time. But it’s not all bells and whistles, especially if you want to sell the property after it has increased significantly in value. In this scenario, you’d be required to pay capital gains tax. With that in mind, this guide has everything you need to know about potentially avoiding capital gains tax on a buy-to-let property.
What is capital gains tax?
Capital gains tax kicks in when you sell an asset for a profit, and this includes buy-to-let properties. Let’s say you purchase a house for £200,000 and sell it for £300,000. That £100,000 is profit, and you’ll likely need to pay capital gains tax on it.
Your tax rate isn’t one-size-fits-all, though. It varies based on annual income and the type of asset you’re selling. It’s not just about property either – everything from stocks and bonds to cars may be liable for capital gains tax.
How is capital gains tax calculated on a buy-to-let property?
If you’ve got a buy-to-let property, then understanding capital gains tax is really important when it comes to selling. For 2023, the tax rates are 28% for higher earners and 18% for anyone in the basic tax bracket.
If you’re a basic-rate taxpayer, selling your buy-to-let could bump you into a higher tax bracket because the profit gets added to your yearly income. In this case, it’s best to speak to a tax expert who can help you avoid any nasty surprises.
When it comes to exemption, you’ve got a £12,300 tax-free capital gains allowance. So, you’ll only pay tax on profit that extends beyond this amount.
Are there any reliefs for buy-to-let capital gains tax?
If you’ve ever rented out a property which you then later sell, you might be eligible for tax relief that can lower your CGT obligations.
Is my buy-to-let property eligible for Private Residence Relief?
Generally, the sale of your primary home is exempt from CGT due to Private Residence Relief (PRR), formerly known as Principal Private Residence Relief. For landlords, PRR can apply if the property you’re selling was once a primary residence. This is to ensure fairness – for instance, if your home appreciated in value over 20 years and was only rented out for one year, it wouldn’t be equitable to pay CGT on the entire 21-year increase. Therefore, you’ll receive tax relief for the years the property served as your main residence, as well as for the final nine months before the sale.
For example, if you bought a property in July 2012 for £200,000 and sold it in July 2022 for £300,000, your capital gain would be £100,000. If you lived in the property for the first six years (72 months) and rented it out for the remaining four years, PRR would apply to 81 of the 120 months you owned the property – 72 months of residence plus the last nine months before the sale. In this case, your relief would be £67,500, calculated as (£100,000 divided by 120 months) x 81 months. Therefore, you’d be taxed on a capital gain of £32,500.
Am I eligible for letting relief?
Previously, letting relief allowed landlords to reduce their CGT by up to £40,000 if the property had been their primary residence at some point. However, this changed in April 2020, essentially eliminating this relief for most buy-to-let landlords. Now, to qualify, you must have resided in the property concurrently with your tenant(s). Landlords who meet this criterion would typically already be eligible for PRR.
Can I make any deductions on my buy-to-let capital gains tax?
You’re entitled to an annual CGT personal allowance, similar to your income tax personal allowance. This is known as the annual exempt amount, which is currently set at £12,300.
For instance, if you had a capital gain of £25,000 in a year from selling an investment property, only £12,700 of that gain would be subject to tax, as the first £12,300 would be covered by your personal allowance.
Certain expenses can be subtracted from your capital gain, such as:
- Fees for estate agents and solicitors
- Stamp duty incurred during the property’s purchase
- Costs for surveys and valuations
- Expenditures related to property improvements, like a new kitchen.
Using the above example of a £25,000 capital gain, let’s say you had spent £15,000 on renovating the kitchen. After this deduction, your total capital gain would be £10,000. In this case, you wouldn’t owe any CGT, as the entire gain would fall within your annual exempt amount.
Are there any exceptions on buy-to-let capital gains tax?
Recent amendments to the rules governing the buy-to-let sector and associated mortgages have financially impacted many landlords. To mitigate this, an increasing number of buy-to-let landlords are establishing limited companies to manage their property portfolios and reduce their tax liabilities.
Profits from property sales made through a limited company are subject to corporation tax, which is currently 19%. This is a more appealing rate for investors compared to the 28% CGT rate for higher-rate taxpayers.
For instance, let’s consider a buy-to-let landlord who has a £60,000 profit from selling a property. They fall into the higher tax bracket, don’t qualify for PRR, and have already exhausted their personal allowance.
In this scenario, they could be looking at a CGT bill of as much as £16,800. However, if they were to sell the same property through a limited company, their corporation tax liability would be limited to a maximum of £11,400.
Best ways to reduce capital gains tax for my buy-to-let
So, what’s the best way to reduce the amount of capital gains tax you pay on a property? Here are some effective strategies to minimise your capital gains liability when selling a rental property.
Maximise your annual capital gains tax allowance
Utilising the annual allowance can reduce your tax bill, especially if you have no other capital gains for the year.
Take advantage of deductible expenses
When selling your rental property, certain costs can be subtracted from your capital gain. These include:
- Capital improvements like adding a conservatory
- Legal fees
- Estate agent charges
- Stamp Duty or equivalent at purchase
- Survey costs
- Advertising expenses for finding a buyer
Consider living in your rental property
If the property you’re selling was once your primary residence, you could qualify for Principal Private Residence Relief. This relief can exempt you from CGT for the period you lived in the property, as well as for the last nine months before the sale.
Utilise your spouse’s tax band
Transferring assets between spouses is generally free from capital gains tax. This can be a strategic move if one spouse has already used up their annual allowance. The property can be transferred to the other spouse, who can then use their full tax-free amount.
Opt for a corporate structure
Holding your rental properties in a limited company can offer several tax advantages. As of April 2023, corporation tax rates range from 19% to 25%, which can be more favourable compared to the 28% CGT rate for higher-rate taxpayers.
By employing these strategies, you can optimise your tax situation and potentially save a significant amount on your capital gains tax bill. However, it’s always advisable to consult a tax professional for tailored advice.
Summary: Gains
Avoiding capital gains tax altogether is tricky if your buy-to-let property has increased in value, but there are ways to minimise the amount you owe. Take advantage of these, and you could save thousands of pounds.
If you’re thinking of selling your buy-to-let property and are after a quick sale, look no further than Property Rescue. We buy your rental home fast without any of the hassle and stress associated with the traditional selling process. Get a free, no-obligation quote and see how much your buy-to-let property is worth.