This article appeared in the Yorkshire Post on Saturday 13th November 2007.

How Changes to capital gains will affect buy-to-let properties

David King Tax Consultant

The Chancellor’s Pre-Budget Report on 9 October 2007 contained sweeping changes to the capital gains tax regime. These will affect the buy-to-let investor.

The current system provides that an individual making capital profits is chargeable to capital gains tax at the rates for income tax on savings income, so the liability can be at 10 per cent, 20 per cent or 40 per cent, depending on the taxpayer’s level of income in the tax year in which an asset is sold. In arriving at the taxable profit there is a deduction for indexation allowance, if the asset was originally acquired before April 1998, which removes the profit that was purely inflationary for the period up to April 1998.

There is then a deduction for taper relief, which depends on the length of time the asset has been owned.

The new system scraps both indexation allowance and taper relief and applies a flat rate of 18%. While the new system is a simplification, the effect of the changes is that there will be winners and losers.

The principal losers will be those taxpayers who have held qualifying business assets for at least two years, and who have achieved the maximum entitlement to taper relief, who would be expecting an effective tax rate of only 10%.

It is clear that the change has been designed primarily to increase the effective tax rate on large profits made by individuals involved in private equity deals, but all business gains will suffer an 18% charge, rather than an effective 10%.

So what do the changes mean for an individual owning residential property that is leased out? Surprisingly, most buy-to-let investors are likely to be among the winners.

For example, assume that a higher-rate taxpayer bought an investment property in June 2000 for £100,000 which is currently valued at £225,000. Under current rules, the tax payable would be about £34,000, whereas under the new rules the liability would fall to some £21,000- a pointer to deferring a sale until after 5 April 2008.   However, where a property has been let as furnished holiday accommodation, the scenario is completely different.

Because under current rules the property is treated as a business asset, the rate of taper relief applying is far more favourable than for an investment asset. In the above example the tax payable would be about £9,000 for a sale before 5 April 2008, increasing to around £21,000 if the sale were deferred to the next tax year. Can anything be done to cash-in the tax saving where there is no immediate sale in prospect? It may be that a capital gains event could be engineered by creating a disposal of the property, perhaps to a trust, but the problem here is that a tax liability would arise on 31 January 2009, irrespective of whether a sale of the property had taken place by then. A spreading of the tax liability may be available, but the Revenue would charge interest on the liability deferred.

Garbutt & Elliott are Chartered Accountants and Tax Advisers with offices in Leeds (0113 2739600) and York (01904 464100).  David King can be contacted at the York office, or by email to dking@garbutt-elliott.co.uk.