If you’ve got a rental property that you’ll eventually sell for more than you paid for it, then there’s a good chance you’ll have some Capital Gains Tax (CGT) to pay when you come to sell it. Sometimes people worry that the longer they keep the property for, the more profit they’ll make when they sell it (because of rising house prices), and therefore the more tax they’ll pay. It’s worth remembering, though, that the highest rate of tax on capital gains is currently 28%, so if waiting for a year meant making an extra £10,000 of profit, your tax bill would increase by £2,800, but you’d still be £7,200 better off!
Things can seem a bit more complicated if you’ve lived in the property for part of the time you’ve owned it. When you sell your own home for a profit, the gain is generally exempt from tax. When you sell a property that was your home for part of the time you owned it, but has been let out for the rest of the time, then the gain is split into two. The portion of the gain that relates to the time you lived there is exempt from tax, and the portion that relates to the time you were renting it out is taxable.
It’s quite common in these circumstances for people to worry that they’re holding onto a property for “too long”, and creating an unwanted tax bill. In the majority of cases, though, it’s very unlikely that keeping the property for longer will leave you worse off. For example:
If you bought a property for £200k in 2018, lived there for three years, rented it out for one year and then sold it for £240k, you’d make a gain of £40k. You lived in the property for three out of four years in total, so ¾ of the gain (£30k) would be tax-free*. So only one year’s worth of gain (£40k x ¼, i.e. £10k) would potentially be taxable. Worst case scenario, you’d pay tax on that at 28%, so a little under £3k, leaving you with £37k profit after tax.
Of course, the longer you own the property for and continue to rent it out, the bigger the portion of the gain that attaches to the period it was rented, leaving a higher proportion of the gain exposed to tax. So if, for example, you held onto the property until 2028, you would have lived in the house for three years out of ten years in total, so only 3/10 of the gain would be tax-free, instead of ¾ of the gain in the first scenario. But having owned the house for an additional six years might mean that you sell it for quite a bit more – let’s say £300k, meaning a gain of £100k. If that were the case, then the tax-free portion of the gain would be £30k, and the taxable portion would be £70k. Worst case scenario, you’d pay tax on that at 28%, so around £20k. But you’re still left with £80k of profit after tax. So despite the fact that you’ve got a much bigger tax bill, you’ve still got £43k more in your pocket.
One situation that could result in you being worse off is if you kept the property for 10 years, but the value didn’t increase in that time. If you sold it in 2028 and still only got £240k for it, then 3/10 of the £40k gain (£12k) would be tax-free, and 7/10 of the gain (£28k) would be taxable. Tax on that could be up to £8k, leaving you with £32k in your pocket, i.e. £5k less than if you’d sold it in 2018 for the same amount.
But the key point is that the potential size of the tax bill alone is a red herring. Whether or not you keep or sell the property should really be an investment decision, and not be driven by concerns about tax. If renting the property for a few more years means you’ll be able to sell it for a higher price in the future, then although you’ll have a bigger tax bill, you’ll still be left with more in your pocket in the end. The only time the tax can make you worse off is if you hold onto the property for longer and the price stays around the same or falls. But if you thought that was going to happen, you probably wouldn’t hold onto it anyway! So in the vast majority of cases, it’s fine to make your decision based on when you think it’s a good time to sell the property in terms of your expectations about the housing market and whether you feel the property is a good investment for you, rather than being driven by worries about CGT.
There are a couple of situations where tax *might* be a consideration, though:
• If the government announced a change to the rate of CGT, that could be a legitimate reason to consider the timing of selling a property. If you knew that the rate was going to increase significantly next year for example, you might prefer to sell now.
• The first £12,300 of capital gains you make in any tax-year are exempt from tax, so if you’ve already sold other assets that are subject to CGT in the current year, you might want to wait until the next tax year to sell the property, so that you can make use of the following year’s exemption.
But those things aside, the overall message is that you’re always likely to be better off by selling your rental property when you can get a good price for it and it’s the right decision for you from an investment point of view. Selling at the time that makes you the most profit will likely mean a higher tax bill, but you’ll still have more in your pocket in the end.
* This is a slight oversimplification, because the final nine months of ownership are also tax-free (this is always the case for a property that was your only or main home at some point), but we’ll set that to one side for now as including it would make the examples more complicated, and it rarely changes the overall picture.