This year’s Pre-Budget Report contained some important changes to the capital gains tax (CGT) regime that will affect buy-to-let (BTL) investors. So what do brokers and their clients need to know?
The current system
Currently, people who own more than one property pay CGT on the difference between the price they paid for a property and the price at which it is sold. This applies to all properties owned, apart from the one in which they are permanently resident. Everyone has a CGT allowance of £9,200 per individual.
Although this allowance is not changing, the rate at which CGT is paid will be different from April next year, onwards.
At the moment the actual rate of CGT you pay is determined by your top rate of income tax. Higher rate tax payers will pay 40 per cent CGT in the 2007/8 tax year and lower rate tax payers will only pay CGT at 20 per cent. But some people can also pay as little as 5 per cent, depending on the assets they are disposing of.
Currently there is also a taper relief system in place that can help people reduce their CGT bill. If an individual’s chargeable gains after allowable losses are more than the annual exempt amount for the year, they can qualify for taper relief, which is calculated depending on how long the asset has been held.
The longer the asset has been held the more relief you can get – after 10 years, only 60 per cent of the gains are chargeable to CGT. This tapering can reduce the effective rate of CGT to 12 per cent for basic rate tax payers and 24 per cent to higher rate tax payers after a decade.
The new system
But in this year’s Pre-Budget Report on 10 October, the Chancellor, Alistair Darling, announced that the current system is being scrapped next year.
Richard Davies, area director of London-based estate agency Chesterton, explains: “The current system of CGT is due to be overhauled in April. This means that the existing taper relief system will be scrapped – a move that will affect a wide range of property owners.
“While everyone will still be eligible for CGT allowance, which currently stands at £9,200, any profit earned over that amount will be charged at a flat rate of 18 per cent. This is good news for those with a second home and BTL landlords, who are presently charged between 24 and 40 per cent, depending on how long they have owned the property.”
However, the announcement is disappointing for those who own a furnished holiday let, as their tax liability is now set to rise from 10 to 18 per cent.
The rationale behind the overhaul has been to make the tax payable by private equity firms and other businesses fairer.
BTL investors
BTL investors are likely to be winners under the new system, although experts are split as to whether the new regime will lead to any significant change in the BTL market.
At the moment, the minimum CGT you will pay on the chargeable gain is 24 per cent, but it could be more, depending on how long you have owned the property – if you have been a landlord for less than three years you face a CGT bill paid at 40 per cent. From next April you will only pay 18 per cent – irrespective of how long you have owned your property.
However if you are a basic rate tax payer you may end up paying more. For example, a basic rate tax payer who has held a BTL property for nine years will now pay CGT at 18 per cent, rather than 13 per cent.
Kensington Mortgages PR manager, Alex Hammond, says: “BTL investors are currently liable for CGT on any gains above £9,200 if they sell within three years of purchase, with higher rate tax payers paying 40 per cent, those in the basic rate band paying 20 per cent, and taper relief available following this period. So a flat rate of CGT of 18 per cent will benefit many investors, but the effect of this change on the market will be limited.”
There are also concerns that there will be a flood of BTL properties being put on the market immediately after the April deadline, as there is now no incentive to invest in property on a long-term basis.
“The immediate impact will be that many BTL investors who were considering selling part or all of their portfolio this Winter are now likely to hold on until next April, while there is no longer a tax incentive for borrowers to hold on to their investment for longer than three years,” adds Hammond. “However, with or without taper relief, BTL should always be considered as a long-term investment. It is certainly not for those looking to make a quick buck and so the new CGT rules are unlikely to encourage a flock of short-term investors to the market.”
Primelocation.com says that the changes to CGT will have a positive impact on the BTL market which, it says, underpins the housing market overall.
The Primelocation.com Prime London Price Index shows that residential property values have grown at an average of 27.5 per cent since January 2005, producing substantial capital gains for many private landlords. A quick example explains how the CGT changes will benefit these landlords.
A property bought for £1 million at the start of the period would have generated a gain of £275,000. The CGT on this at the prevailing rate of 40 per cent would be £110,000, so the net gain would be £165,000. At the new rate of 18 per cent, the CGT would be just £49,500, producing a net gain of £225,500, which is 37 per cent more. The net realisable value of the property moves from £1,165,000 to £1,225,000, an increase of just over 5 per cent.
Primelocation.com CEO, Ian Springett, says: “We would expect the change to stimulate new and increased demand for BTL property and also to reduce supply as landlords who may have been considering selling decide to hold properties they already own.”
Are the changes fair?
However although BTL investors will benefit from the new system, some critics say that this was really an accident on the Chancellor’s part.
“Darling was, in fact, trying to target private equity tax leakage,” says Stuart Law, chief executive of BTL specialist Assetz. “As usual, a rushed policy had unintended consequences – not that we’re complaining on this occasion, of course.”
Law says the changes are also good news for landlords who have refinanced. As an investor owes tax on the sale price of a BTL property, less the original purchase price, those who have refinanced well above the purchase price have previously found themselves potentially owing more tax than the remaining equity in the property – a little known CGT-trap.
“From April 2008, with the new lower rate of 18 per cent, many investors could find it easier to sell the property they have refinanced so aggressively over recent years without incurring a tax bill greater than the equity they release through the sale,” Law says.
But whether the new tax system is fair or not is open to debate. Helen Adams, managing director of first-time buyer advice website FirstRungNow.com, is dismayed by the tax breaks being offered to BTL investors. She says the move is another nail in the coffin for struggling first-time buyers and that the housing market has become a ‘capitalists’ market’.
“Competing and losing to landlord investors for one and two-bedroom properties, first-time buyers are already in a lose-lose situation while landlords are conversely in a win-win position – just about the only disincentive for landlords was the tax on capital gains,” she says. “If the government thinks that first-time buyers will forget this move by the time the next election comes round, it is mistaken.”
However, those on the other side of the fence have a different view point. Neil Young, CEO of property portfolio managers, Young Group, says any notion that BTL investors receive favourable tax treatment is ill informed.
“BTL investors are subject to Stamp Duty when purchasing property and CGT when selling,” he says. “BTL property is an investment asset class in exactly the same way that commercial property and equities are. It should be liable to the same taxation regime. Businesses are entitled to offset interest charges against tax as a business expense, and BTL investments should be treated no differently.”
Young points out that the government was unlikely to remove tax relief from BTL property, as such an act would merely increase the price of rented accommodation, at a time when housing provision is nearing an all time low.
As first-time buyers find it increasingly difficult to get on the property ladder, BTL is often the scapegoat blamed for the recent house price increases, even though it represents just 10 per cent of the market – a market that many experts agree is driven by the undersupply of housing stock. However, the Pre-Budget Report saw Darling also making a commitment to addressing this undersupply by increasing the amount of social housing stock built per year by 50 per cent, to 45,000 by 2010/2011.
Brokers and clients
While brokers are not allowed to advise on tax issues, it is a good idea if intermediaries can show that they have an idea of how the Pre-Budget Report will affect their clients. Possibly some borrowers will feel like the tax structure that encouraged them to invest long-term has been cancelled without warning.
“The basic change is that a flat rate tax of 18 per cent is due to apply from 6 April next year, with account no longer being taken of how long the asset has been held and with the indexation and taper relief being abolished, so the length of time you have held the asset is irrelevant,” says Katie Tucker, technical manager at John Charcol.
However, at the moment there is no clear indication of whether the valuable lettings relief of £40,000 per person on a property is being abolished. If it is, many people who have let out the property that was once their main residence, will pay considerably more tax should they sell.
Melanie Bien, director at Savills Private Finance, says the changes to CGT will make a big difference to landlords and make disposing of properties more attractive. But she dismissed fears that it could destabilise the housing market.
She says: “There have been fears that this will lead to a massive sell-off of BTL properties after 5 April, destabilising the housing market, but I don’t feel that is a real concern. There will always be some landlords who might decide to take advantage of the change in tax and take some profits but the majority are in it for the long haul.”
Any broker advising a client on BTL would be wise to point out that it should be seen as a long-term investment, not a get rich quick scheme. Bien points out that the move should be seen as a welcome change in the tax treatment of BTL which landlords will take advantage of once they come to sell – rather than selling because of it.
“Brokers simply need to know what the tax change is likely to be and the new rate,” she says. “We don’t advise clients on disposal of properties from a tax perspective as we are not tax specialists, and they need to approach a tax specialist if they need specific advice in this area. But brokers should be aware of the proposed changes.”
Essentially, the message for intermediaries should be that the fundamentals of a successful BTL investment remain constant. Investors should ensure they continue buying the right property in the right area, with the right mortgage, and taking a sustainable long-term view to the project.
The prospect of paying less CGT at the end of the investment may come as pleasant news to a borrower, but it is no reason to unduly influence their decision whether or not to enter the BTL market.
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