Capital Gains Tax When Selling Rented-Out Property to Buy Your Dream Home

3 months ago

Selling a rented-out property to buy your dream home is an exciting step. However, the process can be complicated, especially when it comes to taxes. One of the most important factors to consider is Capital Gains Tax (CGT). You may wonder if you have to pay CGT, how much it will be, and whether there are ways to reduce it. In this guide, we’ll clarify the key details you need to know about CGT, particularly for rented-out properties, and provide tips to help you navigate this journey smoothly.

1. What is Capital Gains Tax (CGT) on Property Sales?

Capital Gains Tax (CGT) is the tax you pay on the profit when you sell an asset, such as a property, that has increased in value. The “gain” is the difference between what you paid for the property and what you sell it for, minus any costs associated with buying and selling.

When CGT Applies: You typically have to pay CGT when selling properties that are not your primary residence, including rented-out properties, second homes, or investment properties. However, some exemptions and reliefs can help reduce your tax bill, especially if you lived in the property for part of the time you owned it.

2. Understanding Private Residence Relief (PRR)

Private Residence Relief (PRR) is an exemption that allows you to sell your primary residence without paying CGT on the gain. However, if the property was rented out for a portion of the ownership period, you only receive partial relief. Let’s explore how this affects your taxable gain.

Full PRR: If you live in the property for the entire ownership period, the entire gain is tax-free.
Partial PRR: If you rented out the property at any point, you are eligible for PRR for the months you lived in the property plus an additional 9-month exemption period.

3. How to Calculate CGT for Your Rented-Out Property

Let’s break down the calculation with an example to give you a clearer picture. Assume this scenario:

Property Purchase: £280,000 in July 2021.
Lived In: From July 2021 to 10 September 2022.
Rented Out: From 10 September 2022 to 31 March 2024.
Planned Sale Price: £310,000 at the end of March 2024.
Rental Income: £1,100 per month (minus a 10% agency fee).

Step 1: Calculate the Gain on Sale

Sale Price: £310,000.
Purchase Price: £280,000.
Gain: £310,000 - £280,000 = £30,000.

Step 2: Calculate Private Residence Relief (PRR)

Total Ownership Period: 33 months (July 2021 to March 2024).
Lived In Period: 14 months (July 2021 to September 2022).
Additional 9-Month Exemption: This means you get an extra 9 months of PRR even if you didn’t live in the property during that time.
Total Exempt Months: 14 months (lived in) + 9 months = 23 months.
PRR Calculation: (23 / 33) × 100 = 69.7% of the gain is exempt.

Step 3: Determine the Taxable Gain

Exempt Gain: 69.7% of £30,000 = £20,910.
Taxable Gain: £30,000 - £20,910 = £9,090.

Step 4: Apply the Annual CGT Allowance

Annual CGT Allowance (2023-24): £6,000.
Taxable Amount After Allowance: £9,090 - £6,000 = £3,090.

4. How Much Capital Gains Tax Will You Pay?

The rate of CGT depends on your income tax band:

Basic Rate Taxpayer (20% CGT): The CGT rate is 18% for residential properties.
Higher Rate Taxpayer (40% CGT): The CGT rate is 28% for residential properties.

Example Calculation:

Total Income for 2023-24: £20,000 (including rental income).
CGT on Taxable Gain: £3,090 × 18% = £556.20 (assuming you fall within the basic rate taxpayer bracket).

5. Tips for Reducing Your CGT Liability

Here are some strategies to potentially reduce your CGT:

1. Make the Most of PRR

Ensure you include the period you lived in the property plus the final 9-month exemption. This can significantly reduce the taxable portion of the gain.

2. Deduct Selling Costs

Deduct allowable costs, such as estate agent fees, legal fees, and stamp duty paid when you bought the property. These deductions will reduce the overall gain.

3. Explore Letting Relief

If you have lived in the property at some point while renting it out, you might be eligible for Letting Relief. However, the rules for Letting Relief can be complex, so consulting a tax advisor is advisable.

4. Offset Capital Losses

If you have other assets that you sell at a loss, you can use those losses to offset the gain from selling your rented-out property.

6. When You May Not Have to Pay CGT

You might not need to pay CGT if:

Your property was your main residence: If the property was your only or main residence for the entire period of ownership, you qualify for full Private Residence Relief, making the gain completely tax-free.
The property is sold at a loss: If you sell the property for less than what you paid for it, you won’t owe any CGT. However, you can report the loss to offset future gains.

7. Using the Government’s Online CGT Calculator

To simplify the process, use the UK government's online CGT calculator once you've sold your property. This tool can help you accurately estimate your CGT liability by asking for details like:

Sale price
Purchase price
Ownership period
Selling costs

By inputting this information, the calculator will provide an estimate of your CGT, helping you prepare for any tax obligations.

8. Why Selling Below Market Value May Not Reduce CGT

You might be tempted to sell your property for less than its market value to reduce the taxable gain. However, this approach may not always work:

HMRC Valuation: HMRC might assess the property's market value and use that for the CGT calculation rather than the actual sale price if they believe the sale was conducted below market value to avoid tax.
Proper Valuation: Selling at the right market value ensures transparency and avoids potential disputes with tax authorities. Remember, the figure used for CGT calculations is typically the actual price paid by the new owner minus selling costs.

9. FAQ: Common Questions About Selling Rented-Out Property and CGT

Q1: Do I have to pay CGT if I sell my rented-out property to buy another home?

A: Yes, if the property was rented out for part of the ownership period, you may have to pay CGT. However, exemptions like Private Residence Relief can reduce your taxable gain.

Q2: Can I avoid CGT by reinvesting in another property?

A: No, reinvesting the proceeds into another property does not exempt you from CGT. The tax is based on the gain from selling the current property, regardless of how the proceeds are used.

Q3: What costs can I deduct to reduce my CGT?

A: You can deduct costs such as legal fees, estate agent fees, and stamp duty. However, maintenance and general repair costs are not deductible.

Q4: How does rental income affect my CGT calculation?

A: Rental income does not directly impact the CGT calculation but affects your overall taxable income, which in turn determines your CGT rate (basic or higher rate).

10. Make Informed Decisions When Selling to Buy Your Dream Home

Selling a rented-out property to fund the purchase of your dream home requires careful planning and a clear understanding of the potential tax implications. By calculating your CGT, utilizing available reliefs like Private Residence Relief, and considering deductible expenses, you can minimize your tax liability and maximize the profits from your property sale.

Final Thoughts: Consult a Tax Advisor for Peace of Mind

Every property sale scenario is unique. Using tools like the government's CGT calculator is helpful, but consulting a tax advisor can provide personalized guidance. Make informed decisions, optimize your property transaction, and move one step closer to your dream home.