Selling your rental property at a loss is nothing to be happy about. However, there’s a silver lining even in the darkest of clouds. You can use that loss to reduce the tax you pay for other assets you sold at a profit.
When you sell UK rental property at a loss, you can use the loss to pay less capital gains tax. The loss is deducted from your capital gains for that year. If the resulting amount is lower than the annual exempt amount, and you’ve not used up the loss, you can offset it against future gains.
As with most tax issues, this is no straightforward matter. It has several aspects, which can be an advantage or disadvantage, as I’ll discuss in this article. Read on to learn how to make the most of any losses you make when selling rental property.
To Get Tax Benefits From a Loss, It Has To Be Allowable
You can use a loss on the sale of your rental property to significantly reduce the taxes you owe. To do so, your property has to be considered a chargeable asset.
Your primary residence is not a chargeable asset. So, if you sell it at a loss, you cannot use that loss to reduce the taxes you owe.
However, if you had let out your primary residence, it may qualify as a chargeable asset. If you sell such a house at a loss, you can use that loss to your benefit.
If you have a property that you consider a second home, it is a chargeable asset. So long as any property you own is not your primary residence, any loss you make after selling it will be an allowable loss.
Investment properties, such as buy-to-let houses, are automatically chargeable assets.
Using Allowable Loss From the Sale of Rental Property in the UK
It is worth noting that allowable loss can be used in the future. If you incur an allowable loss of £20,000 during this tax year, and you do not use any of it, you still have £20,000 worth of allowable loss that you can use next year. And if you still don’t use it, you can use it the year after.
If your goal is to pay as little tax as possible, you should make prudent use of your allowable loss.
If you incur a loss this year and don’t have any capital gains, you should ensure you can use that loss next year or the year after, when you have capital gains to pay tax on.
Once you’re sure that the property you’ve sold at a loss is a chargeable asset and the loss is allowable, you have two options:
- You can declare the loss immediately, i.e. during the tax year in which the loss occurred.
- You can defer the declaration. You are allowed to wait for a maximum of four years before you must declare it.
What Happens if You Declare the Loss Immediately
For the purpose of this article, immediately declaring your loss means declaring it in the same tax year it occurred.
If you do so, the loss will have to be offset against any capital gains you make during that tax year. Because the gains and the loss have been made during the same tax year, the loss to gains offset takes precedence over the application of the annual exempt amount.
The annual exempt amount is an automatic relief on capital gains tax that applies to residents of the UK. You only pay capital gains tax if your capital gains exceed the annual exempt amount you are entitled to.
For instance, if you make capital gains of £10,000 and your annual exempt amount is £12,000, then you’ll pay no capital gains tax that year.
If you declare your loss immediately, this is what happens when paying capital gains tax:
- The loss is offset against your capital gains for that tax year.
- The annual exempt amount is applied.
As per our example above, suppose you make capital gains of £10,000 and an allowable loss of £6,000.
- Step 1 in the process above will offset your loss against your gains, and your taxable capital gains for the year will fall from £10,000 to £4,000.
- In step 2, the annual exempt amount of £12,000 will be applied. Since £4,000 is less than £12,000, you will not owe any capital gains tax.
This seems like a good thing because you don’t pay any capital gains tax. However, since the original value of your capital gains that year was lower than your annual exempt amount, you wouldn’t have paid tax even if you didn’t have an allowable loss.
So, you will have lost your allowable loss. During the following year, if you make capital gains that exceed your annual exempt amount, you won’t be able to use the previous year’s loss to reduce the tax you owe.
Let’s look at the second option.
What Happens if You Defer (Carry Forward) the Declaration
You can defer the declaration of your loss for up to four years after the tax year in which the loss was made.
This provision enables you to make maximum use of any allowable loss you incur upon the sale of rental property.
Going back to the example we used in the section above, let’s assume you made capital gains of £10,000 and incurred an allowable loss of £6,000 in the year 2021. With an annual exempt amount of £12,000, you don’t have to pay tax for the year 2021.
The prudent thing to do would be to defer the declaration of the £6,000 allowable loss. If you declare the loss during that tax year, you will lose it.
If you wait until the next tax year to declare it, you have unlocked its full potential.
In the tax year 2022, let’s say you make capital gains of £15,000 on chargeable assets. You can now declare the allowable loss you made in the tax year 2021. Once you do so, you’ll be able to use £3,000 out of the £6,000. This will reduce the taxable capital gains to £12,000. Courtesy of your annual exempt amount of £12,000, you won’t pay any tax.
Moreover, you’ll have a residual £3,000 of allowable loss to use in subsequent tax years.
You Can Lose the Ability To Use Your Allowable Loss
As I’ve explained so far, allowable loss can come in pretty handy. When you make a loss on the sale of a rental property or any other asset considered a chargeable asset, you should make the most out of it.
It is possible for you to lose the use of your allowable loss.
Deferring the declaration of allowable loss is beneficial. It allows you to take full advantage of the loss. However, if you wait too long to declare the loss, you will lose it. The longest you should wait is four years after the tax year in which the loss occurred.
You can also lose the use of your allowable loss if you declare it too soon, as I explained in an example in the section above.
If you declare allowable loss in the same year you incurred it, it is given precedence over your annual exempt amount when determining the capital gains tax you should pay. Essentially, you forego the exempt amount.
Private Residence Relief
Selling UK rental property at a loss is one of the ways you can use to reduce the amount of capital gains tax you owe.
However, there are other methods you can use to legally reduce the tax you ought to pay in a given tax year. Some of these methods have to do with private residence relief.
Using Private Residence Relief for Rental Property
To begin with, if a property is your principal residence, any proceeds from selling it are automatically protected from capital gains tax. But you can also use this provision to your advantage when selling rental property.
If you have lived in a rental property that you own, you qualify for some relief on capital gains tax when you sell it.
For instance, if you owned a rental property for ten years and lived in it for the first three years, you can claim private residence relief (PRR). Assuming you made capital gains of £10,000, your PRR amounts to £3,000 (3/10 * 10,000). Your taxable capital gains will therefore be £7,000.
You Can Shift Your Residence To Reduce Capital Gains Tax
Capital gains tax can be quite the burden, especially if your personal income puts you in a high tax bracket.
In the UK, if you earn more than £50,000, you pay capital gains tax at a rate of 28%. Otherwise, you are subject to a rate of 18%.
At a 28% rate, if you make capital gains of £100,000 on the sale of rental property, you pay £28,000.
Taking advantage of private residence relief (PRR) in the above situation can significantly reduce the tax burden.
But the only way to use PRR is to have actually lived in a residence. You are free to nominate a property as your main residence provided you do it within two years of your acquisition of the latest property.
When claiming the PRR, you’ll have to provide proof that the residence was your primary residence. If there are inconsistencies, you could be fined heavily for tax evasion.
Proof may constitute utility bills, bank statements, and being on the local electoral register.
If you decide to follow this route to reduce the capital gains tax you pay, please consult a tax expert.
Also, keep in mind that a married couple can only nominate one main residence between them. Doing otherwise can be construed as tax evasion and lead to legal consequences.
Another way to go, which is unlikely to get you in trouble for tax evasion, is using a company as a vehicle for your investments.
Incorporating a Business Can Help You Pay Less Tax
Capital gains tax only applies to the sale of rental property owned by individuals. The sale of rental property owned by companies is covered under corporate tax.
If your income is higher than £50,000, you might gain significantly by using a company to handle your rental property.
Limited liability companies pay a corporation tax of 19% on profits. Capital gains made through the sale of rental property are treated as corporate profits and taxed at 19%.
Compare the 19% to the 28% you’d have to pay on corporate gains as an individual in the higher-income tax bracket. Holding all other factors constant, it is better to operate your buy-to-rent business as a limited liability company. In other words, you should create a company and incorporate it.
However, it’s not that easy. Incorporating comes with challenges. At times, it is not worth the trouble.
The Downside of Incorporating Your Buy-To-Rent Business
One of the main challenges of incorporating your business to avoid capital gains tax is the transfer process, which can expose you to more tax.
This won’t be a problem if you are incorporating to take advantage of the tax holiday in future transactions. However, if you are incorporating now with the hope of getting a tax break on property you already own, it may be a futile process.
A company is a legal entity that exists separately from the owner. If you want to sell an asset through the company and pay the lower corporation tax, the company has to own that asset.
The obvious solution is to transfer ownership of the asset to the company.
However, to do that, you’d have to sell the property to the company. This would expose you to stamp duty tax (to be incurred by the buyer i.e., your company) as well as the capital gains tax you sought to avoid in the first place (to be incurred by the seller i.e., you).
When you buy property in the UK, you are required to pay stamp duty tax that varies according to the value of the property. There are certain situations where you don’t have to pay stamp duty when buying property.
Final Thoughts
If you sell rental property at a loss in the UK, you can use the loss to pay lower capital gains tax, both in that tax year and subsequent years.
To get the most out of your allowable loss, it is prudent to wait until the next tax year to declare it. This gives you more control over how your allowable loss is used.
Other ways to reduce the tax burden when dealing with rental property include converting a rental property into your main residence and incorporating your buy-to-rent business.
Sources
- GOV.UK: Capital Gains Tax: What You Pay It On, Rates, and Allowances: If You Make a Loss
- GOV.UK: Rates and Allowances for Corporation Tax
- GOV.UK: Set Up a Private Limited Company and Incorporate It
- GOV.UK: Tax When You Sell Your Home: If You Let Out Your Home
- Just Do Property UK: How Much Tax Do You Pay On a Second Property?
- Unbiased UK: Can I avoid capital gains tax on my buy-to-let property?
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