Capital gains tax - what could change in the near future?
UK landlords have had to contend with multiple tax hikes in the last few years. As a result, many predicted that Chancellor Rishi Sunak would announce yet another rise in capital gains tax in the 2021 Budget.
This hike, however, did not materialise. Instead, the annual exempt amount was maintained until the end of the 2025-26 tax year, with the Government stating that, “Maintaining this allowance at its 2020 to 2021 levels is a responsible decision that helps ensure that the post-crisis task of putting the public finances on a sustainable path is no harder than it needs to be.”
But could the freezing of capital gains tax for such a long period of time come with its own problems?
This article will summarise the capital gains tax situation as it stands and certain changes that are being proposed. We’ll offer some high-level information on how this will affect landlords as well as some practical tips on how to prepare.
What is capital gains tax?
Capital gains tax is a tax payable on the profit you make on the sale of an asset. Some of the most common examples of assets that are subject to capital gains tax are property, real estate and bonds. You may be liable for capital gains tax if you sell a property that isn’t your primary residence for a profit. This could include a rental property or a second home.
How much capital gains tax do landlords currently have to pay?
From 6 April 2020, the annual exempt amount of capital gains tax for individuals and personal representatives increased from £12,000 to £12,300. For trustees of settlements, the annual exempt amount increased to £6,150 from £6000.
The level of capital gains tax differs for basic rate taxpayers, but it is currently set at 28 per cent for higher and additional rate taxpayers.
UK residents currently have to pay capital gains tax within 30 days of completing the sale.
They were previously able to wait until the end of the tax year to include it in their annual tax return.
HMRC has provided a tax calculator to help work out how much capital gains tax you have to pay, if any. The calculation is based on the gain – which means the market value of your property, minus any estate agents’ fees, solicitors’ fees, and the costs of major improvement work such as building an extension. More modest improvement works, such as redecorating, would not be included.
What does the 2021 Budget really mean for capital gains tax?
There was a great deal of speculation about whether capital gains tax would increase in the 2021 budget. Considering the ongoing financial impact of COVID-19 and the furlough scheme, it seemed feasible that the Chancellor could opt to increase tax rates, including capital gains tax, to recover costs. However, the Government also needed to carefully consider how increasing taxes of any kind would impact on public spending and injecting some much-needed cash back into the economy.
Earlier this year the Government asked the Office of Tax Simplification (OTS) to look at whether capital gains tax was fit for purpose. The OTS report, which was published on 11 November 2020, recommended a closer alignment of income tax and capital gains tax rates. Capital gains tax is traditionally lower than income tax and contributes significantly less to the UK economy – around £8.3bn of capital gains tax was paid in 2017-18 compared with £180bn of income tax from 31.2m individual taxpayers.
On the sale of second homes, the rates are currently 18 per cent for basic rate taxpayers and 28 per cent for higher rate taxpayers. The OTS recommendations, if implemented, would see the tax rate on capital gains tax for buy to let properties rise to 20 per cent for basic rate taxpayers. The rate for higher rate taxpayers would rise to 40 per cent.
The OTS report also called for a significant reduction in the annual tax allowance. The annual amount that’s exempt from capital gains tax currently stands at £12,300. This could be lowered to just £2,000 under the new proposals.
However, as yet, these proposals have not yet been implemented – and with the Government promising to leave capital gains tax untouched until the end of the 2025-26 tax year, it appears that landlords have been let off.
It is a positive result, after some experts warned that increases in capital gains tax and a reduction in the annual tax allowance could result in landlords leaving the sector altogether.
This, in turn, could mean a reduced supply of available rental properties and increased rates for tenants. Landlords have had to contend with a raft of challenges in recent years; the impact of COVID-19, changes in mortgage interest relief, the wear and tear allowance, to name just a few. There is a real danger that landlords would jump ship altogether rather than incur a far larger capital gains tax bill.
What landlords must remember, though, is that a recovering economy could well mean that property will continue to rise in value. The latest HM Land Registry data revealed that house prices fell by 0.5 per cent between December 2020 and January 2021. However, the data also shows that the average annual UK price rise is 7.5 per cent.
Should house prices continue to rise, the Government’s limitation of the capital gains tax threshold could well mean that more and more landlords will be liable for capital gains tax payments on any property that they sell.