Capital Gains Tax

At a public meeting, attended by the Chartered Institute of Taxation and senior members of HM Revenue and Customs on 21 November, it was confirmed that the Chancellor has re-emphasised his commitment to a reduction in the rate of Capital Gains Tax [CGT] to 18% from 6 April 2008. This is despite the pressure he has come under from the CBI and other representative bodies not to eliminate the potentially lower rates of tax that currently exist for business owners. Buy-to-let investors have been identified as potential winners from this change.

If the proposed changes are indeed enacted, Mr Darling will abolish existing reliefs, including taper relief and indexation relief and introduce a flat rate tax of 18%. Someone who is liable for income tax at 40% would currently pay CGT at an effective rate of 24% on a property owned for 10 years. The effect of taper relief is to reduce the taxable gain in stages between 3 and 10 years ownership.

However someone with a relatively small profit who is otherwise liable to income tax at the basic rate can find that taper relief reduces the effective rate to just 12% after 10 years. Such an individual will be worse off under these proposals, although it will be relatively rare for a buy-to-let gain on a property held for ten years not to push the investor into the higher rate tax bracket.

Property Case Study

Mr Jones, a higher rate taxpayer, bought a property for £180,000 on 15 August 2002 and it is now worth £275,000. Ignoring anything spent on the property to improve it, if it is sold before 6 April 2008 the gain will be £95,000, which will attract 15% taper relief, reducing the taxable gain down to £80,750. Ignoring the annual exemption tax on this at 40% will be £32,300. This is an effective rate of tax on the gross gain of 34%, so Mr Jones would definitely be better off delaying a sale of the property until after 6 April.

There are other reliefs to take into account which could well affect the outcome. For example, if the property has ever been lived in as a residence by the investor, and an election has been made for "principal private residence" relief, the taper calculation is usually more complicated. In such a case a further relief of up to £40,000 should also be available. As far as we know, both these reliefs are set to stay when the headline rate of CGT comes down to 18%.

It is not all good news however. Potential losers are investors who hold properties acquired prior to 6 April 1998. Indexation relief, which increases the base value of the property by inflation according to the RPI, will be abolished under the new rules. This relief was frozen in April 1998, but anyone with investment property acquired before then will lose the benefit of indexation unless some action is taken before 5th April 2008.

Indexation Case Study

If Mr Jones had bought his property in August 1982 instead of 2002 for say £60,000 then he would have a gross gain of £225,000, but would be entitled to indexation allowance of £62,820 and taper relief of £60,872 reducing the taxable gain to £91,308, tax on which would be £36,523, an effective rate of 16.99%, so Mr Jones would be better off selling the property or at least preserving the available reliefs prior to 5th April 2008 if he can.

At the above-mentioned meeting, HMRC officers accepted that planning to capture old indexation relief would be effective and that there were no plans to counter this with anti-avoidance legislation. There are a variety of ways in which the available reliefs can be preserved by taking action before 6th April 2008, even if there are no immediate plans to sell a property. Taking action now may well save some capital gains tax when a sale does take place in future.

So there are two key things for buy-to-let investors to consider:

1. Will I be better off without taper relief after 5th April?
2. Is there an amount of indexation relief that I can "bank" before the law changes?

For answers to these questions and advice on how to make the best of the current and new legislation contact:

Carol Wells - Head of Private Client Tax Services at Irwin Mitchell Solicitors - 0370 1500 100 or drop us a line.

After an initial discussion about your circumstances it is often possible to agree a fixed fee for the work involved.

Irwin Mitchell is a leading UK law firm who have a team of qualified tax professionals able to deal with all aspects of personal tax advice and compliance.