Rental Income Tax & CGT - What should I do?

Edtough

I have a bit of a complicated situation that I'm trying to understand. I intend to seek some professional tax advice, but before I do this, I just want to educate myself as much as possible.

I have a flat that I bought 5 years ago and lived in for 4.5 years, and have rented out for the last 6 months.

I have moved out to another house I've bought, which I live in with my fiancee.

My intention is to sell the flat in 4 years. I will have owned the flat for 9 years by then (4.5 years lived in, 4.5 years rented).

I am a higher rate tax payer, and so currently pay 40% on the rent from the flat. My other half is a lower rate tax payer, so I have looked into doing the necessary to have her as the receiver of the rent and therefore only pay the lower rate on it. But this comes with CGT implications when selling.

So bearing in mind I intend to sell the flat in 4 years, my question is, in the minefield of CGT, 3 year rule etc etc, would I be better off paying the higher rate tax on rent for 4 years, or taking advantage of fiancee's lower rate tax but lose CGT allowances? The expected gain on selling the flat would be £100k, and the gross rent per month is £850.

It should be an easy calculation, but for an amateur like me its hard to know if you've covered everything; bread and butter stuff for you guys I am sure.

Oh and one other complication; if I receive the rent then my income goes over £50k which means we lose £80 per month child benefit....another advantage to my other half receiving rent.

Thanks in advance.

00ec25

First and most important. You are not yet married therefore any transfer to her done now counts as a CGT disposal. This has no impact on you (see calculation below) but for her if you gift it then she becomes an owner with a zero purchase cost and so her gain would not be the same as yours as it would be with reference to 2 different start dates. Once you are married then its OK to gift as that is on a no gain/no loss basis where she inherits your original purchase cost and would therefore share in the 100K gain figure

CGT if wholly owned by you
calculate in months not years but using years for speed. 3 year rule amended to 18 months wef April 2014
owned 9 years.
PRR exemption 4.5 + final 18mths = 6/9 x100k = £66.6K
liable let period 9 - 6 = 3/9 x100k = £33.33K
letting relief: lower of gain in PRR period or let period or £40k, so lowest = 33.33K
net taxable gain 100 - 66.66 - 33.33 - 11k (personal allowance) = 0
no CGT to pay, personal allowance not used at all

CGT if shared ownership
she will not get PRR so will not get letting relief
she will get personal allowance
if you own it 50/50 post marriage:
- she will be liable on £100k x 50% -11,000 = £39,000 payable at 18% and some at 28% (if worst case applies all at 28% tax = £10,920, if best case applies 39x18% = £7,020 payable)
- you will have zero liability because of PRR and letting relief

if you own as tenants in Common with unequal shares then do the above calculation on her share, you remain zero liability

rental income and marriage
once you are married then the share of the rental income attributed to her must reflect the actual ownership proportions between the two of you (if unequal) otherwise the default 50/50 will apply
if unequal ownership you must notify HMRC of this using Form 17

if you to own 100% then the income tax due on the rent bearing in mind you don't say what the net profit is per month so using the worst case that all 850 is pure profit then you would pay 4.5 years x (850 x12) x 40% = 18,360 income tax , obviously the actual figure would be lower since it is taxed on net profit not gross rent

as you are trying to reduce your exposure to 40% tax and loss of child benefit the best fit solution for you and her cannot be worked until you know your net rental profit and how much of her CGT liability would be at 28%. There is almost certainly a case for making her an owner but how much to give her needs further work

Edtough

Wow, what a reply. Thanks 00ec25!

So it's an advantage for us to be married?

To clarify a few things, net rental income would be £9180 per year.

My wife (to be) works part-time with a salary of £15k, so she wouldn't get into the 28% CGT band.

If we do a 99/1 split with ownership (her/me), would that mean only 1% of the gain would be subject to my PPR expemption and letting releif etc?

00ec25

Edtough wrote: »

So it's an advantage for us to be married?
yes - the one bit of tax law not changed with the introduction of individual persons' taxation was the favourable treatment of married couples for CGT
To clarify a few things, net rental income would be £9180 per year.
so the income tax exposure is: 3,672 @40%

My wife (to be) works part-time with a salary of £15k,
so she is already a basic rate tax payer so the maximum income tax saving is £1,836 if 100% of the income was hers. For that to happen she would need to be the sole owner, so the amount of income tax at stake is a relatively small sum

so she wouldn't get into the 28% CGT band.
depends on size of her share of the gain. The 18% rate only applies to the amount of the gain which falls into the remaining basic rate income tax bracket
eg: using the 39,000 share figure from before:
15,000 earned income - 10,000 income tax personal allowance = 5,000 taxed at basic rate
income tax basic rate bracket is 0 - 31,865.
so
CGT gain at 18%: 31,865 - 5,000 = 26,865
CGT gain at 28%: 39,000 - 26,865 = 12,135
CGT payable on 39,000 gain = (26,865 x18%)+(12,135 x28%) = £8,233

If we do a 99/1 split with ownership (her/me), would that mean only 1% of the gain would be subject to my PPR expemption and letting releif etc?
yes - now see below!

transfers between (legally) married spouses are made free of CGT and there is no limit to how many you do BUT in respect of property the amount transferred must represent the legal position as well. So she would need to be on the deeds for that actual share
the usual tactic therefore is for a transfer/gift to be made setting up the wife as the majority owner so she accounts for that % of the income at her income tax rate. using the classic 99/1, she gets 9180x99% of the rental profit (keeping you below the child benefit level?) and "saving" 1,836x99% of income tax as she would only be paying at 20% not 40%
HMRC must be notified of the share on Form 17
http://search.hmrc.gov.uk/kb5/hmrc/forms/view.page?record=TS9D3da9t7I&formId=5159
it is vital that you remain an owner throughout the time otherwise you would lose your PRR and letting relief if there is a gap in ownership

at a point in time before the property is sold the relative ownership proportions are altered by a new gift putting wife down to only that % needed to use up her personal allowance and not to tip over into her having a taxable gain. Obviously for a brief period the income tax due on the rental profit will rise. It is a bit of a grey area how long before sale you can do this, HMRC regard this as active tax avoidance and can be bothersome over it if you get the wrong tax inspector

In your example with a 100K gain she would own 11% and have 11,000 of allowance, you would own 89% and have zero liability if sold after 9 years of ownership since your calculation will always come to zero whatever % you own given 100K gain over 9 years with 6 years of PRR and a letting relief value which is always <£40,000

Edtough

That's really helpful! I have a much better understanding of this, now someone has explained it to me.

So my plans will be:

-Get married
-Transfer 99% of flat to wife as a gift.
-Notify HMRC with Form 17
-Some time before we sell, reduce the wife's share down to a % that will be covered by her personal allowance.
-Sell flat

I had no idea you could adjust the %ownership again before selling.

ognum

Edtough wrote: »

That's really helpful! I have a much better understanding of this, now someone has explained it to me.

So my plans will be:

-Get married
-Transfer 99% of flat to wife as a gift.
-Notify HMRC with Form 17
-Some time before we sell, reduce the wife's share down to a % that will be covered by her personal allowance.
-Sell flat

I had no idea you could adjust the %ownership again before selling.

The one thing I'm not clear on is whether you have a mortgage on this property?

If you do you will need to speak to the mortgage company about a transfer of ownership.

Does you wife have enough income to get the mortgage.

Edtough

Fortunately there is no mortgage on the property, so that will make the transfer of ownership all the easier.