By Penny Bates
Penny Bates of accountancy firm Menzies
The economic situation over the past year or so has been difficult and words such as "credit crunch" are now quite common.
This has badly affected the housing market with sales declining.
Some people still have to move as a result of job changes or family circumstances.
But if they rent out their home, rather than trying to sell it in a depressed market, they have some opportunities to save tax while waiting for the housing market and the availability of mortgages to improve.
That is because there are a number of tax breaks available to the home owner who moves away and lets his home, and either buys another property elsewhere in the UK or rents.
Capital Gains Tax
The basic rule is that if the house you are leaving has been your only or main residence throughout the period of ownership, any gain in the value when you sell is exempt from capital gains tax (CGT) under the principal private residence rule (PPR).
Where you have vacated the property for a number of years, any gain in the 36 months afer moving out is also treated as exempt from CGT.
Some people are now having to relocate and, being unable to sell, are letting the property they have vacated.
If the property is let to tenants, and was previously the owners' main residence, the owners should also qualify for another relief from CGT - lettings relief.
This could be available in any period where the house was not the main residence and does not fall within the 36 months.
These two reliefs can be substantial.
How they work
Broadly, lettings relief is worked out to be the smaller of:
- £40,000 or
- an amount equal to the exempt amount for the owner-occupied period.
To understand how this works, take the example of a house you own and have previously lived in, but which you have been letting for some years.
You sell it this year for a total capital gain of £80,000.
Of that gain, £36,000 accrued while you were living in it, and in the three years after you moved out.
So that sum is exempt from CGT under the PPR rule.
That leaves £44,000 potentially still liable to CGT.
However that gain is reduced by the lower of:
- £40,000 or
- £36,000 (under the rule shown above).
Thus, in this case, the gain of £44,000 is reduced by £36,000 leaving just £8,000 liable to capital gains tax.
However, the CGT annual exemption will also be available if not used against another sale in the same year.
The exemption is currently £9,600, which exceeds the net gain of £8,000 in this example - so the result is that no CGT is payable at all.
The lettings relief is available to spouses and civil partners in respect of jointly owned property, so it could be worth as much as £80,000 per couple.
Income tax can be reduced too.
House sales may be falling but there is still demand for rental properties
Where a loan is secured against a rental property - typically a traditional buy-to-let - the interest on that loan is allowable as a deduction against the rental income received.
This means that the interest paid on the loan reduces, for tax purposes, the net rental income, and hence reduces the amount of tax payable.
Where an individual leaves his home, and lets it as discussed above, he would often like to buy a property in the area he is relocating to.
Obtaining a mortgage may be a problem in the current climate as he already has one on the home he is now going to let.
But if he is a good borrower with a good credit rating he may be able to persuade his lender to give him access to further funds, secured against the old property the family are leaving.
This may be sufficient in some cases to purchase a property in a lower cost area or at least give him a healthy deposit to arrange finance for the new property.
The tax benefit of taking out this new mortgage, secured on the original property that is now being let, is that all the interest paid on this second loan will be available to set against the rental income received for that property.
This means that he can release equity from his rental property to use to buy his new family home, or indeed for any other purpose as there is no restriction on how he spends the money raised.
The reasoning behind this is that the letting of property is considered to be a business for tax purposes.
The Revenue agrees that relief is due and the following example is taken from their Business Income Manual to illustrate how it works.
Mr A owns a flat in central London, which he bought 10 years ago for £125,000.
He has a mortgage of £80,000 on the property.
He has been offered a job in Holland and is moving there to live and work.
He intends to come back to the UK at some time.
He decides to keep his flat and rent it out while he is away. His London flat now has a market value of £375,000.
He renegotiates his mortgage on the flat to convert it to a buy-to-let mortgage and borrows a further £125,000.
He withdraws the £125,000, which he then uses to buy a flat in Rotterdam.
Although he has withdrawn capital from the business the interest on the mortgage loan is allowable in full because it is funding the transfer of the property to the business at its open market value at the time the business started.
So, tax saving opportunities are available for those having to relocate and letting their old property and these can be very valuable.
If in doubt professional advice should be taken to structure this correctly as it is sometimes difficult to change arrangements after the event.
The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.