Properties that are used as your principal private residence and also let out to tenants may qualify for one further relief. Private letting relief, as its name suggests, is available for lettings to private individuals who use the property as their home. Lodgers are normally exempt (unless you are running a boarding house), so it usually applies to people who have stopped living in a property themselves and are letting it out to others.
To qualify for Letting Relief you must have occupied the property as your main residence yourself at some time. It doesn't matter when or for how long - even a week may be enough. However, if you have a second home, you must elect for the property to be your principal private residence within 2 years of starting to occupy it in order for this relief to be available. If you miss this deadline, you are then at the mercy of HMRC who will decide which property is your principal private residence and when according to the facts presented. If you are in this situation, you would be well advised to either live in the property long enough for its status as your main residence to be beyond dispute or sell the other property first.
For the property to qualify as your main residence, you will need to do more than just move in for a short period. You will need to show that you intended to make it your main residence and not just a temporary stay before returning to your other property. This normally rules out holidays although you could make a holiday home your main residence if you can show that you are now using it for more than just another holiday. Some degree of permanence must be present. You can normally do this by changing your address on things like bank statements, driving licenses or pensions. You could also send your children to a local school for a while. Even a week could be enough if you are between homes.
How does Letting Relief work? It is always the smallest of the following 3 figures:
- the chargeable gain (attributable to lettings)
- the exempt gain (attributable to PPR relief)
- £40,000 per owner
Void periods should be excluded from this calculation. If a property is not let out for the whole time it is excluded from PPR relief, you must split the chargeable gain between the let period and the void period, based on the exact number of days.
The following example will illustrate this. Jack and Vera bought a house for £150,000 on 1st May 1999. The house is in Jack's sole name. On 30th April 2008 they moved out and let the house to Tyrone, who lived there until 30th April 2014 when Jack sold the house for £650,000.
His unrelieved capital gain (ignoring buying and selling expenses) is £500,000. He is entitled to PPR relief for 10.5 years as it was his main residence for 9 years and the last 18 months are exempt. He owned the house for 15 years so only 30% is chargeable. This reduces the gain to £150,000.
Now we need to calculate letting relief. This will be the smallest of the following 3 figures:
a) The exempt gain = £350,000
b) The non-exempt gain = £150,000
c) The maximum relief = £40,000
Letting relief is £40,000 so the chargeable gain is £110,000. Jack deducts his 2013/14 annual CGT allowance of £11,000 and pays tax on £99,000. His CGT bill will be at a combined rate of 18% and 28%.
Let’s assume Jack earns £25,000 per annum and has no other income. His personal allowance for 2013/14 is £10,000 and the higher rate threshold is £31,865. That means £16,865 of his basic rate tax band is unused. That part of the gain is taxed at 18%. The balance of £82,135 is taxed at 28%. His total CGT bill is £26,033.
Assume now that Jack put half the house in Vera's name shortly before they moved out. She is also entitled to the maximum relief of £40,000 so it doubles to £80,000. The smallest of the 3 figures is now £80,000 and the chargeable gain falls to £70,000 between them. Moreover, Jack and Vera can now use both their annual CGT allowances so the taxable gain is only £48,000.
If we assume Vera also earns £25,000 and has no other income, only £14,270 of their combined gains is taxed at 28%. This produces an overall CGT bill of £10,067 a saving of £15,966 just for having the property in joint names. That is a reduction of over 61%.
However, this does not work if the house is only put into joint names after they move out. If it was not in joint names before, they would need to go and live there again (for maybe a year or so) for the PPR exemption to be backdated for Vera. Even then, she would not get Letting Relief if she was not joint-owner when the house was let out, so it is best for transfers between spouses and civil partners to take place a) whilst they are living there, and b) before tenants move in.
Of course, Jack could have avoided Capital Gains Tax completely, even with the house in his own name, if he had sold it within 3 years of letting it. The final period of ownership only went down to 18 months on 6th April 2014 so any disposals before then still enjoy the 3 years.
And if he had sold the house on 1st October 2012 (just 18 months earlier) there would only have been a taxable gain of £4,955 (assuming he could have sold the house for the same price) which would have produced a CGT bill of just £892 even if the house was in his name only.
This illustrates how much Letting Relief can save you just by living in a house for a few years, but it also illustrates how fast a Capital Gains Tax liability can build up when you start letting a house or a flat that was previously your home. Once the 18 months are up, a tax bill may start to clock up very quickly, even if property prices are relatively stable.
The main problem is that the £40,000 maximum relief has been frozen since 1991. Once intended to act only as a ceiling, it now restricts Letting Relief in most cases. Unless the Government puts it up, it will eventually wither on the vine and become increasingly irrelevant. For the time being, however, Letting Relief remains a valuable tax-planning tool for so-called “accidental” landlords.
One last point - if you let residential property and you are hoping to make use of this relief, make sure none of your tenants run a business there too otherwise you will lose some of it.