Let’s be honest – buying a new property can be a pretty expensive affair. That’s why many property owners rent it out for some extra income.
However, if you have a buy-to-let property, you must keep in mind the different types of taxes that will need to be paid for it.
On that note, the most notable one is the capital gains tax on a buy-to-let property.
If you are not careful with your finances, you might end up spending most of the earnings from the property on paying CGT. Thankfully, there are some ways by which you can keep this spending in check.
That is just what we have discussed in this guide. So, if you are curious, then dive right in!
Disclaimer: When it comes to taxes, this is just general advice and not to be relied upon as fact. When it comes to tax everyone’s position and circumstances are different and the rules are changing all the time. Only by seeking advice of a qualified tax professional can you be certain you are complying with all the relevant tax rules & regulations.
Table of Contents
- What Is Capital Gains Tax?
- Capital Gains Tax On a Buy-To-Let Property
- How Is Capital Gains Tax Paid?
- How To Avoid Capital Gains Tax On a Buy-To-Let Property?
- How To Reduce Capital Gains Tax on a Buy-To-Let Property
What Is Capital Gains Tax?
First, let’s talk about what capital gains tax or CGT actually is. It is the tax that you need to pay on the “gains” made from an asset when you dispose of it in any way.
When we say “dispose of an asset,” we are referring to any one of the following activities:
- Selling the asset
- Swapping or trading it for something else
- Transferring the asset to someone else, mostly as a gift
- Getting compensated for the asset when it’s damaged or lost
CGT is only applicable to the profit you have made from the asset and not to the total amount you get for it.
For example, if you have acquired an asset for £10,000 and you then sell it for £25,000, then your profit will be £15,000. The CGT will only be enforced on this amount and not the selling price or the buying price.
Capital Gains Tax On a Buy-To-Let Property
In simple terms, a buy-to-let property is a type of property that you purchase for the sole purpose of renting out.
As such, you can generate revenues from this property, which technically makes it an asset. Because of this reason, you will be liable to pay CGT on the gains you make from selling or renting the property.
Luckily, most people do not have to pay taxes for selling their main residential property since it is subject to private residence relief.
Beware, though – this tax relief is only applicable if you have a single property and have lived in it for as long as you have owned it.
So, if you have rented it out at any point of time in the past, you might not be eligible for private residence relief. That’s because it will likely be considered a buy-to-let property in that scenario.
How Is Capital Gains Tax Paid?
You are expected to pay the CGT amount to the HM Revenue & Customs (HMRC), which is the primary regulatory body in the UK for collecting taxes, payments and customs.
According to the regulations, you must pay the CGT within 60 days of selling or renting your buy-to-let property.
That means you will have a period of two months to notify, calculate and pay the CGT amount to the HMRC, which is a relatively short time. If you fail to do that, you will have to pay interest and a penalty amount to the HMRC.
Moving on to specified tax rates for CGT, basic-rate taxpayers will be liable to pay 18% CGT on the profits made by disposing of a buy-to-let property. Conversely, higher-rate taxpayers will be charged up to 28% CGT on the same.
Here, you need to keep in mind that the tax will be levied on all the profits made on the property’s value since it was purchased. Naturally, this will complicate the tax calculations for those who have rented their property for extended periods.
If the amount of profit has crossed £6,000, you’ll need to report it to the HMRC and pay the tax amount within the stipulated time.
How To Avoid Capital Gains Tax On a Buy-To-Let Property?
Frankly speaking, there is no established method that you follow to avoid CGT completely.
However, there are certain strategies that you can use to minimise the amount of tax you pay to the HMRC.
Most of these methods rely on utilising tax reliefs and allowances, and they are applicable to any property you own that is not your primary residence.
For your convenience, we have listed all of these strategies below.
How To Reduce Capital Gains Tax on a Buy-To-Let Property
1. Tax-Free Allowances
Every taxpayer in the UK today is eligible to claim a tax-free capital gains allowance on their profits. This annual allowance is applicable on amounts up to £12,300.
Keep in mind that you won’t be able to carry this allowance forward to the next financial year. Therefore, if you have used up a part or all of the allowance amount on other assets, you should hold on to your buy-to-let property until the following year.
Once the financial year ends, you can sell the property and then utilise the tax-free allowance amount to reduce the CGT.
2. Joint Ownership
Joint ownership is another way by which you can reduce the CGT amount on your buy-to-let property.
Those who are married or in a recognised civil partnership can consider transferring a part of the property’s ownership to the spouse/partner. That, in turn, will reduce the tax liability on the profits you generate by selling the property.
Basically, legally recognised civil partners or married couples can combine the annual tax-free allowance to save more money. Naturally, you will need to consider the tax bands that you and your partner belong to while calculating the tax.
3. Cost Deductions
You can deduct all the allowable costs from the CGT amount to minimise the amount you have to pay. Some of the deductible costs that are allowed include:
- Solicitor fees
- Stamp duty
- Estate agent fees
- Capital improvement costs
Unfortunately, costs for maintenance and upkeep and mortgage payments are not deductible. So, you’ll need to keep that in mind while calculating the tax and talk to a qualified tax advisor.
4. Set Up A Limited Company
Landlords who are higher-rate taxpayers may choose to set up a limited business to minimise their tax liabilities.
The property will be covered under corporation tax in that scenario, which has a taxation rate of 19%. That is much less than the CGT tax rate of 28%, thereby helping the landlords save money.
Read more: Buy To Let Mortgages for Limited Companies
So, these are some of the strategies you can use to reduce (but not avoid) the CGT on your buy-to-let property.
If you can manage your finances properly, you can save a lot of money here, which is always a desirable aspect.
Depending on the nature of your property, there may be other types of taxes that you’ll need to pay, such as income tax, inheritance tax and so on.
However, CGT is possibly the most significant one of them all, which is why it is important to know all about how you can minimise it.
We always suggest speaking to a qualified tax advisor with regards to any tax you may be liable for.
**A buy to let mortgage will be secured against your property.
Some types of buy to let mortgages are not regulated by the Financial Conduct Authority.
All content is written by qualified mortgage advisors to provide current, reliable and accurate mortgage information. The information on this website is not specific for each individual reader and therefore does not constitute financial advice.