Decision: Sell flat & invest or keep flat as investment

Se99paj

Background

I'm currently living in my partner's house and I've been renting out my own flat for about 19 months. My current tenants will be moving out in September and I'm looking at options regarding the flat.

Future plans 3-5 years

My partner has fixed her current mortgage for 2 years so won't move anytime soon. But we're probably going to outgrow the house in the next 3+ years. The money might come in handy for the short-term if we needed to bump up the deposit on the next house, or alternatively I could use this as an opportunity to setup a future income.

Flat Info

The estimated value is £210k, located in Guildford, Surrey. Great location as it's in the countryside but can be in Waterloo within 30 mins. House price index shows very little increase over the last few years, but expect that might change in the current environment with stamp duty changes as it's 1 bedroom so desirable for first time buyers. I have about £70k left on the mortgage and 1 year left on a fixed term.

Options

1.) Self the flat & Invest

I don't think there is a future investing in property due to the tax charges and I see this getting worse. I also didn't buy the property as an investment and would like someone else to enjoy it as their first property.

I could take the £140k from the sale and invest, I'd look to split the money across low/high risk funds. I'd transfer as much as possible to an ISA each year. As a short-term investment this might not be a good approach as I would be charged 10% CGT if/when I sold the funds, But longer term once the funds are all held in an ISA this would be tax free. 

2.) Keep the flat

I'm probably breaking even each year renting out the flat when you consider the service costs and tax charges. But the mortgage is reducing £400 each month so I can't really complain, there's still another 15 years on the mortgage.

I could keep very long-term and keep the rent as an income. I can keep the flat for the short-term and sell, the value might increase but the mortgage definitely will decrease, I’m also not sure where I stand on CGT. As this is my only property, I don’t contribute to my partners mortgage in anyway and we’re not married, am I exempt from all CGT? 

Keeping the flat also means the investment is locked into the property, so might be difficult to get out when I need it.

As a short term investment keeping the flat seems to make the most sense as CGT is an issue with investing. But in the long-term selling the flat makes the most sense as I believe the gains will be higher and its more tax efficient. Would be interested to hear other peoples opinions

Pfffill

Keep the flat if you can afford to, even when you and your partner move; property has been king for decades now, and while that will one day change, I don't see it happening any time soon.

El_Torro

I often tell people that renting out a property isn't a great investment. I also own a Buy to Let property which I rent out so make of that what you will.

I think there is a place for BTL in a portfolio, though only if you already have decent pension provision and perhaps other investments too, such as Stocks & Shares ISAs. So whether or not you should keep your flat and rent it out depends on what other investments (especially pension provision) you have. Diversification is key and having all your eggs in property is not a good idea.

DireEmblem

You need to ask yourself how easily you need access to the funds, and how much risk you are willing to take.  It sounds like you would like the option to use it in 3-5 years, so that probably knocks off investing.

Have you checked out the situation of the housing market at the moment as well, if you did decide to sell today?  You will get a lot of different opinions, but if letting out covers all your costs and a bit more - you say £400 a month, then in 3-5 years time you will have an extra 15-25k paid off your mortgage would you not?

Depending what size of mortgage you can take on as well, I think you can get a BTL mortgage with a 25% deposit, so you could release equity that way as well, to negotiate better terms on both your BTL and future property.

bowlhead99

Se99paj said, I’m also not sure where I stand on CGT. As this is my only property, I don’t contribute to my partners mortgage in anyway and we’re not married, am I exempt from all CGT? 

No, you're not exempt. 

People don't need to pay CGT on their 'principal private residence' and if they live in multiple places they can say which one is their main one. A married couple is assumed to have only one PPR between them but as you're not married that would not apply to you.

However, as you have let your flat out on a tenancy where the tenants use it for themselves, to the exclusion of you, you can't pretend it was your principal residence while the tenancy was running. Clearly, you were living with your girlfriend or elsewhere for that portion of your overall period of ownership.

When you eventually sell it, you can have relief on the gain you made for the fraction of the time that it's been your PPR, but not for when it hasn't. As it can take a while to sell a property, there's a concession that as long as you lived in it at some point, you can say it was also your your PPR for your final months of ownership. That final 'grace period' was reduced from 18 months to 9 months by this year's Finance Act which received Royal Assent last week.

So as an example: 
You keep it a few more years and then sell it, for a total £80k profit after estate agent and solicitor fees.

In total you owned it ten years - let's say 4 years 3 months living there initially, 5 years six months tenanted, and 3 months at the end when the tenants are out and you move back in to do it up and sell it. The law allows you to claim all the last 9 months as PPR even though tenants were there for some of the time,  so in total you have 4.25 years plus 0.75 years = 5 years principal private residence relief, and the other 5 years out of the total ten has no relief.

So if you sell up for £80k gain you'd get relief on 5/10ths of it, which is £40k, and then you get your annual exemption for the first £x thousand of gains in a tax year when you make the disposal (currently £12.3k but may be a bit more by then, let's say £13k). This leaves £27k gain.

CGT on residential property is higher rate than it is on shares and investment funds, at 18% for basic rate taxpayers and 28% for higher rate. So if all the gain fitted into your basic rate band (if there's space for it after that year's rental income and employment income) you'd be paying tax 18% on £27k which is about £5k. So not a huge amount of the £80k, but not tax free, and it really depends how much PPR you can claim based on the time periods involved.

If there isn't space for the gain inside your basic rate band in the year you sell it (eg the higher rate threshold that year is £50k and your earnings and rental income is £43k so there's only £7k of basic rate band left) then from the £27k of gain not covered by your annual exemption would be split, with the first £7k at 18% and the remaining £20k at the higher 28% rate, for a blended rate of closer to 25%.

By contrast, the CGT rates on shares and investment funds that can't fit into an ISA are only 10 and 20% rather than 18 and 28%, and you also have a dividend allowance of £2k a year (and after that, the dividend tax is only 7.5% for a basic rate taxpayer).

The good thing about gains on investment funds rather than on a single property is that you can sell some shares each year to make a gain and use up your annual CGT exemption and then buy a slightly different fund with the proceeds. So for example if you had £150k invested in Fund A and it had grown to £170k, there would be a gain of £20k if you did the entire lot, but you could instead sell just half of it and only make £10k of gain, which fits inside your annual exemption, no tax bill. Then you use the proceeds to buy shares in Fund B, and are left with £85k of shares in A (standing at a gain compared to their purchase price of £75k) and £85k of Fund B (no gain or loss).

So the CGT consequences of holding unwrapped funds while you gradually wrap them up in ISAs or pensions, may not be too bad. And funds are a diversified and liquid investment, while a single flat on a single street in a single town near one city in one country, is not immune to the risk of a bad tenant who destroys the place while failing to pay you for months before they can be evicted. And who knows the level of demand for a 30 minute commute to Waterloo in the future - Waterloo passenger numbers were down 95% in April, and though they've rebounded somewhat, there are millions of people who have discovered in recent months that traveling to London every morning isn't something that they necessarily need to do to hold down a job.

The advantage of holding a property rather than an investment funds portfolio is that you can get the bank to finance a large part of it and hold a cheap £70k mortgage (or more) to support the income stream and potential capital growth of a £200k property, whereas you wouldn't get £70k of bank finance on a £200k ISA and pension portfolio. You might also think that you don't really need the 'liquidity' of an investment fund portfolio because you would only sell out of these 'life savings' in the long term to buy into a future property with your partner and you won't be doing that on zero notice, so the ability to take cash out of your investments from time to time is not so useful, you could just keep the flat.

But generally with the relatively better tax environment for financial investments (especially if you become a higher tax payer) as well as diversification, being an 'accidental landlord' is certainly not the great thing that people read about in the past.

Investments are of course not very suitable for short term holding period because they may drop heavily in value, so if you have an ambition to buy into your partner's place in the short to medium term they may not be a good vehicle for saving your money. At least, despite the huge tax disadvantages, a Guildford flat is likely to be affected by the same sort of market conditions as whatever UK property you eventually buy.

Thrugelmir

How long is left on the lease of the flat? 

Albermarle

depends on what other investments (especially pension provision)

I agree with this . OP - what pension provision do you and your partner have ? Often a pension is the most tax friendly way to invest 

Se99paj

Pfffill said:

Keep the flat if you can afford to, even when you and your partner move; property has been king for decades now, and while that will one day change, I don't see it happening any time soon.

This is a debate I have with a friend over and over again, property has obviously been king in the past but I believe the direction is changing, increased stamp duty, changes to tax relief, higher CGT, prices that have been stagnant for years. Whilst you could invest money tax free, with no hassle and almost guaranteed growth (Unless you invest in something really bad)

Se99paj

El_Torro said:

I often tell people that renting out a property isn't a great investment. I also own a Buy to Let property which I rent out so make of that what you will.

I think there is a place for BTL in a portfolio, though only if you already have decent pension provision and perhaps other investments too, such as Stocks & Shares ISAs. So whether or not you should keep your flat and rent it out depends on what other investments (especially pension provision) you have. Diversification is key and having all your eggs in property is not a good idea.

Thanks for the advice, pension is looking good and I've been putting money into a S&S ISA for a few years, also have easy access emergency funds.

Se99paj

DireEmblem said:

You need to ask yourself how easily you need access to the funds, and how much risk you are willing to take.  It sounds like you would like the option to use it in 3-5 years, so that probably knocks off investing.

Have you checked out the situation of the housing market at the moment as well, if you did decide to sell today?  You will get a lot of different opinions, but if letting out covers all your costs and a bit more - you say £400 a month, then in 3-5 years time you will have an extra 15-25k paid off your mortgage would you not?

Depending what size of mortgage you can take on as well, I think you can get a BTL mortgage with a 25% deposit, so you could release equity that way as well, to negotiate better terms on both your BTL and future property.

In 3 years I'd have £14k paid off the mortgage, 5 years would be £24k - But there are always unknown costs that could put a dent in the profits. 
With a £140k investment and 6% interest I'd be £27k in profit after 3 years & £48k in 5.
The value could increase, but it would need to be 3% or higher to outperform investing.

Se99paj

bowlhead99 said:

Se99paj said, I’m also not sure where I stand on CGT. As this is my only property, I don’t contribute to my partners mortgage in anyway and we’re not married, am I exempt from all CGT? 

No, you're not exempt. 

People don't need to pay CGT on their 'principal private residence' and if they live in multiple places they can say which one is their main one. A married couple is assumed to have only one PPR between them but as you're not married that would not apply to you.

However, as you have let your flat out on a tenancy where the tenants use it for themselves, to the exclusion of you, you can't pretend it was your principal residence while the tenancy was running. Clearly, you were living with your girlfriend or elsewhere for that portion of your overall period of ownership.

Thanks for the advice, is there anything that you can reference that would back this up? It would make complete sense to me that I should pay CGT whilst I was letting the flat - Just haven't been able to reference a clear example.
I've done the maths on CGT and I should have enough annual exemption for 2 years before it starts to hit me - It makes a big difference after year 2.

So the CGT consequences of holding unwrapped funds while you gradually wrap them up in ISAs or pensions, may not be too bad. And funds are a diversified and liquid investment, while a single flat on a single street in a single town near one city in one country, is not immune to the risk of a bad tenant who destroys the place while failing to pay you for months before they can be evicted. And who knows the level of demand for a 30 minute commute to Waterloo in the future - Waterloo passenger numbers were down 95% in April, and though they've rebounded somewhat, there are millions of people who have discovered in recent months that traveling to London every morning isn't something that they necessarily need to do to hold down a job.

I think this is the biggest benefit with funds, I can invest in 100's of funds across the globe, that target a range of industries with varying risks that I can pick. Compared to the 1 bedroom property market in Guildford that I'm leaving in the hands of my tenant.
Regarding the routes to Waterloo, I was thinking slightly differently - People would realise they no longer need to live/work in London and would look for properties further outside but within reachable distance for the 1-2 days a week they do need to come into the office. A 1 bedroom flat in Guildford might be a bit more scenic then a pokey houseshare in London.