New Capital Gains Tax (CGT) rules are on the way which may affect couples who are splitting up and plan to sell their home eventually, accidental landlords and those who have bought a new home without selling their old property.
Although the changes are due to come into force from April 5th 2020, decisions made now can create a future tax bill for those unaware.
Under current rules, those selling their home will qualify for ‘Private Residence Relief’ which means they pay no CGT on any increase in the value of the property since they purchased it. If they instead decide to rent out their home, they will still qualify for Private Residence Relief provided that the property is rented for 18 months or less.
Under the new rules, the 18 month exemption period reduces to 9 months.
Example: You make a gain of £200,000 when selling your home which you have owned for 12 years. You lived in the whole property for 6 years and then let the whole property out for 6 years.
You’re entitled to Private Residence Relief for the 6 years that you lived in the property.
In addition, under current rules, you get relief for the last 18 months you owned the property even though you didn’t live in it.
This means under current rules, you get 7.5 year of relief out of 12, which translates to 62.5% of your gain. You therefore won’t pay tax on £125,000 of the gain.
Under the new rules, you get 6 years (the time you lived in the property) + 9 months (the reduced exemption period) of relief out of 12 years. That’s relief for 81 months out of 144. So under the new rules, you won’t pay tax on £112,500 (in other words, £12,500 more of your gain will be subject to CGT).
Those who have purchased a replacement property before selling their old home may find themselves with a larger tax bill than expected. Under the new rules, they will have just 9 months to sell, rather than 18. Currently the Home Owners’ Alliance say it can take six months to sell a typical property from start to finish, but complicated chains and transactions falling through affect about 50 per cent of sales.
Couples who have split up and still own a property may also find themselves adversely affected by the changes. Where one moves out and purchases another property, the clock starts to run – and the home occupied by their former partner must be sold within 9 months if they are to avoid a CGT bill on any gains. Often sorting the finances is the most difficult part of splitting up and can take considerable time, particularly if the matter relies on the time of the family court. Legal advisors are concerned that people may decide to cohabit after splitting up just to avoid CGT – aside from the stress this can cause, it can also make obtaining a divorce more difficult.
Changes to Lettings Relief
At present, those who have made a gain on the sale of their home may be able to reduce their tax bill further with lettings relief.
In the example above, under current rules, you would not pay tax on £125,000 of the gain under current tax rules (i.e. 6 years + 18 months exemption = 7.5 years exemption, so you would pay CGT on £75,000). But under current rules, letting relief reduces the gain even further – it is worth the lowest of the following:
- The same amount you got in Private Residence Relief, or
So in this instance you’d reduce your gain by a further £40,000 and pay CGT on just £35,000.
However, from April 6th 2020 lettings relief will only be available where you shared occupancy with your tenant. This might be for example if you rented out a room to a lodger in your home. In most cases this relief will not apply.
In addition to the groups mentioned already, couples who owned properties individually before purchasing a larger property together may also be caught by the changes. Whilst the surplus properties may until now been a good rental income opportunity, from April the loss of lettings relief will make the proposition of renting out seem less attractive for some.
Experts are concerned that awareness of this change is minimal and consequently many people will be caught by the new higher tax. According to accounting firm RSM the tax changes are expected to raise £470 million over the next 5 years (source: The Times).