Whenever you dispose of (i.e., sell) a property, which is not your main residence, you’re obliged to calculate and pay capital gains tax (CGT) on any profit made, which exceeds your annual capital allowance. Even if the property in question was once your main residence, if you’ve since rented it out or let it sit empty, CGT will apply to gains made from the sale. The same goes for the disposal of other so-called ‘capital assets,’ like personal possessions worth over £6,000.
However, when it comes to disposing of a property you lived in whilst also renting out a part of it, you can minimise your capital gains tax bill by leveraging capital gains letting relief—a tax exemption scheme which can prove particularly useful to part-time landlords, small business owners and multiple-property owners.
Explaining Capital Gains Tax (CGT) on the sale of UK property
The UK’s tax authority HMRC requires tax to be paid on any gains made—after certain expenses and deductions—from the ‘disposal’ of personal assets like property.
If you only own one property—likely your ‘main residence’—then the sale of your home would be exempt from capital gains tax (CGT). If the property you sell was once listed as your main residence but no longer is, then your CGT bill can be reduced via the Private Residence Relief scheme.
However, if you own multiple homes and sell one which has never been registered with HMRC as your main residence, then you are obliged to calculate, declare, and pay tax on the profits made.
For example, if you bought a second home for £200,000 and sold it five years later for £250,000, you’ve made a £50,000 profit. After deducting allowable expenses such as estate agent fees, solicitor fees, your annual capital allowance of £3,000, and the costs of any structural repair work carried out—let’s say £20,000 in all—you’d have made a £30k profit on which you’d have to pay capital gains tax.
The CGT rate depends on your income band. Higher and Additional Rate taxpayers pay different capital gains tax rates than Basic Rate taxpayers do. CGT rates on the disposal of property are also different to the CGT rates applied to other asset classes. Capital gains tax rates on the sale of property tend to sit somewhere between 18-28%.
What is Capital Gains Tax Letting Relief?
Like Private Residence Relief on capital gains—which reduces your tax bill by a percentage equal to the length of time the property was your main residence—there is another type of relief for homeowners who chose to rent part of their home whilst still living there. This is called the ‘Capital Gains Tax Letting Relief’ or ‘Capital Gains Letting Relief.’
Capital gains letting relief applies to the sale of properties which were:
- Registered as your ‘main residence’ at one point in time, and
- Which were part-rented to another lodger, or lodgers, whilst you lived there.
At its most basic, the letting relief scheme says that whatever portion of your home you rented out whilst living there should be tax exempt when the home is sold.
For example, let’s say you rented out 1 of the 4 equally sized floors of your first home to help you pay the mortgage—capital gains tax letting relief could exempt you from paying tax on 25% of the gains made from selling that house when the time comes.
In real terms, you must choose which of the following three options given by HMRC is the lowest, when applying letting relief to your capital gains:
- The same amount you got in Private Residence Relief
- £40,000
- The same amount as the chargeable gain you made while letting out part of your home
How has Letting Relief changed in recent years?
Prior to April 2020, capital gains tax letting relief was a great boon to landlords who let out their properties. The letting relief helped landlords minimise their capital gains tax bill when disposing of rental homes, and as such was exploited as a tax benefit to being a landlord.
Since April 2020, however, the rules governing the letting relief scheme have changed quite dramatically, ultimately becoming much stricter and of less use as a tax benefit for landlords. Nowadays, letting relief can only be applied to gains made from the sale of a main residence you rented out whilst also living there yourself.
These changes have made calculating capital gains tax letting relief a little more complex, since both Private Residence Relief, CGT Letting Relief, and regular capital gains tax are all liable to affect your tax liability.
How to calculate your Capital Gains Tax Letting Relief
Before diving into calculating your capital gains bill or the reductions to it that letting relief can offer, it’s wise to acknowledge the savings (both financial, and in terms of time and stress) that a personal tax advisor can help you secure—especially in the age of Making Tax Digital.
If you’d rather go DIY, however, then here’s a laundry list of the information you’ll need to hand if you’re to calculate your capital gains letting relief by yourself:
- The total profit you made from the sale of your property.
- Deduct what you initially paid for the property from the value you sold it for, then deduct from that number any allowable expenses.
- The number of years during which the property was listed as your main residence versus how long you owned the property for in total.
- You’ll need this as a percentage (e.g., 4 out of 10 years = 40%).
- The percentage of the property which was rented out during your time also living there.
An example CGT Letting Relief calculation
You buy your first home (Property A) for £150,000, and for the four years you live there, you rent out one of the larger en-suite bedrooms to a lodger. You then buy a new house (Property B) and move in, registering it as your new ‘main residence’ with HMRC.
For another four years, you rent out Property A as a landlord before putting it up for sale. You sell Property A for £250,000, making a gross profit (i.e., capital gains) of £100,000. After deducting allowable costs like legal fees and listing fees, you calculate your net gains as £80,000.
In total, you owned Property A for eight (8) years, and for four (4) of those classified it as your main residence—i.e., for 50% of the time. The room you rented out for the four years you lived there took up 15% of the total area of the property.
In this example:
- The four years (50%) during which you did not live in the property are considered fully liable for capital gains taxation—i.e., on 50% of the chargeable gains of £80k.
- The four years (50%) during which you did live in the property are eligible for a mixture of Private Residence Relief and Letting Relief—i.e., on the other 50% of the £80k.
Your net gains from the sale of the property are £80,000. According to our above calculations, 50% of this £80k profit is to be taxed at your capital gains tax rate (let’s say it’s 24%).
£40,000 x 0.24 = £9,600.
You owe HMRC £9,6000 in capital gains tax.
After you deduct your capital gains allowance of £3,000 per year, you owe just £6,600.
The other 50% of the profits, however, relate to the four years during which you lived in the house and rented the big bedroom out. The big bedroom, we calculated, took up 15% of the home, meaning you occupied the other 85%.
As such, 85% of the remaining £40,000 in gains is covered by Private Residence Relief, meaning you do not have to pay capital gains tax on £40,000 x 0.85 = £34,000.
The remaining £6,000 (relating to the 15% of the home that you rented out during the four years you lived there) is covered by Capital Gains LettingRelief and so is considered tax exempt.
How to leverage Letting Relief to reduce your CGT liabilities
The capital gains tax letting relief scheme is not what it used to be. Whilst landlords up and down the country used to be able to claim letting relief against gains made on the sale of their rental properties, this was effectively rendered impossible by changes to the law introduced in April 2020.
Thankfully, though, that doesn’t mean you can’t still leverage the letting relief scheme to reduce your capital gains bill. Since it’s up to you to calculate, report, and pay capital gains tax to HMRC, understanding the ins and outs of letting relief could help you dramatically reduce your liabilities.
In a world where tax laws are ever-changing and landlords must stay compliant with numerous regulations, including financial considerations like whether or not to pay VAT on rent, it can be challenging to minimise your capital gains bill all by yourself.
For optimised tax efficiency and minimised CGT, consider consulting the experts today.
