Selling your buy-to-let? Here are some tricks to cut your tax bill
Use your pension and other investments to reduce, or defer, your capital gains tax liability
Recent property price rises mean that most landlords will face hefty capital gains tax bills when they sell their properties.
By Nicole Blackmore
Many landlords are thinking about selling their buy-to-let properties ahead of tax changes announced on July 8 that threaten to wipe out much, if not all, of their profits.
The new tax will be phased in over coming years, giving investors some time in which to sell. But the problem most will then face is a hefty capital gains tax liability.
Selling an investment property triggers a CGT liability based on the increase in value of the asset during ownership, minus certain costs.
Lucy Brennan of accountant Saffery Champness said where you have lived in a property as your main home, for any point of your ownership, that period is discounted when calculating the gain – in a process called “apportionment”.
How CGT is applied
The rate of tax you pay on a capital gain is calculated by adding the taxable gain to your taxable income.
If you remain within the basic rate tax band, you will pay 18pc tax on the gain. If you fall into the higher rate tax band, you will pay 28pc on at least some of it.
For 2015-16, the personal income tax allowance is £10,600 and the basic rate band is £31,785. Anyone with income over £42,385 pays higher rate tax on the excess.
Everyone is entitled to tax-free capital gains, worth £11,100 this tax year. Only gains above this are taxed.
If you earn £20,000, for example, and make a taxable gain of £10,000 (after your £11,100 annual allowance), the £30,000 total will fall within the basic rate band and you will pay 18pc CGT.
If on the other hand you earn £35,000 and make a taxable gain of £25,000 you will be in the higher rate band. The £7,385 of the gain which is still within the basic rate band will be taxed at 18pc, while the amount over £42,385 will be taxed at 28pc.
Aside from well-known steps to reduce your CGT bill, such as transferring a share of the property to a spouse to utilise their CGT allowance, private letting relief and principal private residence relief, there are some little-known tricks that can save you thousands.
Use your pension
By making a lump sum contribution to your pension, you could save up to £4,000 on your CGT bill.
All pension contributions worth up to £40,000 a year, or 100pc of your salary if it is lower than £40,000, attract tax relief at your marginal rate.
Stephen Berry, a chartered financial planner at NFU Mutual, said a pension contribution can be used to reduce the tax you pay on capital gains by boosting your higher rate threshold.
Take someone who earns £45,000 and who makes a taxable capital gain of £25,000. They would pay CGT at 28pc, giving a tax bill of £7,000.
But by making a gross pension contribution of £28,000, they would receive tax relief on the contribution. This means that higher rate tax is only payable on income over £70,385 (£42,385 + £28,000), so the £25,000 gain is taxed at 18pc, rather than 28pc.
The CGT bill would fall to £4,500 – a saving of £2,500.
The most that can be saved through this trick is £4,000.
Use an investment vehicle
There are a couple of ways to offset, or delay, paying CGT, which could reduce your overall costs. These methods are more risky because they require investment in small and often start-up companies, so are only recommended for experienced investors with a diversified portfolio.
“Investors with a CGT liability might consider investing in Enterprise Investment Schemes (EIS),” said Jason Hollands, of adviser Tilney Bestinvest. “You would get an income tax credit but EISs can also be used to defer a CGT liability.”
EISs offer a 30pc income tax credit to investors who buy shares in small, unlisted companies. The minimum holding period is three years.
Landlords with a CGT liability could postpone the gain they have made by investing the equivalent amount in EIS shares.
“Through CGT deferral relief, the liability would only recrystallise when you sell your EIS shares,” Mr Hollands said. “In theory, higher rate taxpayers could defer the liability until they retire and become basic rate taxpayers, or continue rolling over the liability right up until death, when EIS shares would be exempt from inheritance tax and the CGT liability would dissolve.”
Alternatively, as existing EISs are released, an investor could crystallise a portion of the gain to use up their annual allowance and then reinvest the remainder of the original gain in further EISs, repeating the process until the CGT liability disappears. The investor would also be eligible for further 30pc income tax relief each time they reinvest.
Take a higher rate taxpayer who sells a buy-to-let property and makes a taxable gain of £100,000. They have a CGT liability of £28,000.
Investing the chargeable gain of £100,000 into an EIS would enable them to claim 30pc income tax relief, worth £30,000. In effect they get £100,000 of investment for a net cost of £70,000.
In addition to this income tax relief they also defer their payment of the £28,000 CGT liability while they are invested in these companies.
So they are getting an upfront tax benefit of 58pc (30pc income tax credit and deferral of the 28pc CGT liability), providing they are not claiming more income tax relief than the income tax they would be liable to pay that tax year. They must hold the EIS shares for at least three years to benefit from these reliefs and when they exit, the original capital gain of £28,000 is recrystallised. However, any returns on the EIS shares themselves are tax-free.
To take advantage of these reliefs, you need to subscribe to an EIS in the 12 months before, or 36 months after, the date of the sale of the property that triggered a gain.
“EIS companies are small, young, unquoted and high risk,” Mr Hollands said. “It is really important to understand that you may not be able to realise your investment in a set time.”