The new government’s decision to increase capital gains tax will have a fundamental impact on the returns that buy to let investors can expect to make. This should force any existing investor to reassess their portfolio and also prompt all potential landlords to carefully calculate the impact.
The new government plans to increase capital gains tax (known as CGT) to as much as 40% or 50%. This is a tax that is charged on the profit (or capital gain) that is recorded from buying and selling assets such as houses or shares. The reason for the increase is clear enough. At its current level of 18% there is a huge incentive for people to try to change income, which is taxed at the normal income tax rate, into capital gains.
In fact, every buy to let investor that uses an interest-only mortgage to minimise income tax is taking advantage of the difference in these two rates of tax because it reduces the amount of tax paid on monthly rental because most of it goes to paying interest on the mortgage. The fact that one could do this and wait for houses to increase in value, with most of that profit being taxed at the lower rate, was a major attraction for many higher-rate tax payers to invest in residential housing.
The bigger worry for the government was not really BTL investors, but those in business and areas such as private equity funds because most of the payment that goes to these people is calculated on capital gains. So in many ways moving to equalize the tax between the two is fairer.
But the new tax could be unfair in one very important respect and that is when it comes to inflation. If property prices rise in line with inflation their owners aren’t actually becoming any richer. Yet they will have to pay a tax of 40% or 50% no that increase in value.
How to protect your Buy to Let Portfolio from CGT
Investors need to quickly take stock of their current portfolio and assess how vulnerable it is to a rise in capital gains tax. If you are an investor who has been relying primarily on rising property values to provide the majority of your income and return then you should reconsider your portfolio with an eye to earning ongoing rental yield from it. If you have several properties that you have owned for many years and that have increased in value considerably, accumulating capital gains all this time, then you may need to sell one or more of them so that your profits are taxed at the current lower rate. You can then reinvest the proceeds in new properties with current market values, which essential sets the clock to zero on the gains.
If you are a couple and are buying properties you should also consider the fact that British tax law treats both partners separately. So it makes sense to ensure that both are able to take full advantage of tax-free income allowances in each tax year. This is also important if you have several properties as there is also an annual capital gains tax allowance before which you have to start paying tax, so it may be more efficient to stagger the sale of properties over several years to save on tax.
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