A lot of landlords keep an old home and turn it in to a rental. What does that do to the tax on the growth in value? It might not worth how you think.
Let’s paint a scenario. Bob bought a house in 1989 for £250,000. He moved out of it in late 2007 when it was worth £650,000 and started renting it out. The house is now worth £750,000.
To summarise in the 18 years he lived there, the tempt period, it went up £400,000. in the 18 years since, the taxable period, it has gone up £100,000.
When he sells the house this year he will logically be thinking that he will pay tax on the £100,000. Note for this purpose I am ignoring the extra principal private residence relief that would exempt the final nine months of ownership.
This isn’t what happens though. For capital gains tax purposes HMRC will assume the growth in value accrued evenly over the total ownership. Some of you will have spotted where this is going already.
Bob thought he would have £400,000 of exempt growth and £100,000 of taxable growth. Not so. The total growth of £500,000 is spread evenly. Half of the ownership is exempt and half is taxable based on the number of years of occupation and rental. On that basis £250,000 of the growth is taxable and only £250,000 of growth is exempt. That makes a staggering difference to the tax position.
Bob thought his bill would be about £24,000 whereas it will be nearer to £60,000. THat’s tax for you! Always kicking you when you least expect it!
Ironically the value of £650,000 is relevant for income tax purposes and will be the value used to determine how much mortgage interest is allowed for tax relief! So if Bob remortgaged up to £650,000 (unlikely I know but just to make the point!) he would get tax relief on the full mortgage interest. It would be restricted to 20% credit like all interests but the important point is that the whole mortgage would be allowed and not the £250,000 original purchase price.