Private Residence Relief (PRR) and Lettings Relief and the impact on property investment (Part 2)

As we have seen over recent years, investing in property as a landlord is largely betting against Government policy. We have witnessed, what are possibly the most aggressive tax levy’s, removals of tax allowances and policies to make alternatives to residential property as an asset class more attractive.

The objective is clear, in making buy to let unattractive there is a hope that the reliance of residential property as an investment, which is peculiar to the UK when compared to our European neighbours, will diminish. In turn it is hoped that it will become easier for first time buyers to get on the housing ladder. This is simple supply and demand economics. If properties are no longer desirable to investors then demand will go down and the supply will effectively increase for those who are looking to property for its primary function, accommodation.

The blog written by my colleague Richard Winward will deal with changing landscape in greater detail but, in brief, we have seen the following policies introduced:

• A 3% surcharge to Stamp Duty Land Tax in relation to property purchases for those with more than one property.
• The removal of offsetting mortgage interest against rental profits leading potentially to tax being paid on profits that no longer materialise.
• A reduction in the Principle Private Residence Relief available for Capital Gains Tax tapering from 36 months to 18 months and as from April 2020, 9 months.
• A restriction to the application of lettings relief.
• The lowering of capital gains tax rates on all other asset classes leaving property an inefficient investment from a tax point of view.
• Councils being able to apply a surcharge for Council Tax on empty properties.

Add to this the potential risk of rising interest rates and many are either finding that they are no longer receiving sufficient returns for the investment risk taken or have concerns that they will not be sufficiently rewarded in future. Consequently, many landlords are taking the decision to sell their buy to let properties or at least reduce the number they hold.

Rather than being, in my opinion, an aggressive tax charge, there is an additional tax change that is seemingly aimed at fairness rather than a deterrent to property investment. This relates to the application of the spousal exemption for capital gains tax.

By way of example...

Let us consider a property purchased by Mrs A as her main residence prior to marriage. Mrs A has owned the property for five years. Of those years, Mrs A lived in the property as her main residence for the first two years. On marriage to Mr A they moved into his property letting out her former home. This continued for most of the remaining three years of ownership baring for a short period prior to sale when they moved back in to the property.

Until April this year, providing a property has been the owner’s main residence for a period of time then Private Residence Relief (PRR) applies. This automatically treats the last 18 months of ownership as deemed occupation as the principal residence. Consequently, for Mrs A, of the last 60 months of ownership, 24 was actual occupation as her main residence and 18 months deemed as occupation as the main residence. Therefore 42 months in total are exempt from capital gains tax, any gain being reduced proportionally by 42/60ths.

This leaves 18/60ths of any capital growth subject to capital gains tax ignoring any additional allowances and exemptions.

Under the current legislation there is an opportunity for Mrs A to transfer the ownership of the property to Mr A without tax implication owing to the inter spouse exemption that applies for capital gains tax. If this transfer of ownership occurred after moving into the property as their main residence but before its subsequent sale, on sale Mr A is able to claim for 100% of the time he owned the property he occupied as his main residence thus there would be no liability to capital gains tax to consider and a considerable tax advantage achieved.

This is set to change. From April 2020 on transference of the property between spouses the recipient spouse will inherit the occupation history accumulated by their spouse over the period of ownership.

Whilst, as indicated earlier, this logically seems a fairer tax practice than the current regime it also signifies another nail in the coffin of the profitability of buy to let property.

Whilst recipients of substantial personal injury compensations will often favour or perceive greater security from investing in tangible assets and many will be positively encouraged by family members from previous generations to invest in property due to the historic performance achieved, as with all asset classes the past is rarely a reliable indicator of future returns. The landscape has simply changed. So, a further nail in the coffin yes, but the death knell possibly not. Rather it is a political step closer on the agenda, surely?