Understanding Capital Gains Tax When Selling Rental Properties to Tenants
I own three rental properties, all with excellent long-term tenants. I want to sell these properties to my tenants at a discount, as it is the only way they'll get on the property ladder. This would mean a quick and easy sale for me and a reward for our long and mutually beneficial relationship.
However, I'm concerned about the tax implications. If I sell the houses below market value, will my capital gains tax be based on the selling price or the market value of the house?
Harvey Dorset, of This is Money, replies:
It would be fair to say that many landlords aren't focused on the futures of their tenants, and their hopes of making it onto the property ladder. That is understandable, as property is an investment after all. However, it is nice to see that this is a concern for you, and that you feel you could help your long-term tenants by selling your properties for less than they are worth.
If you have owned these for a while, their respective values could have increased considerably since you purchased them. To find out how you can work out what kind of tax bill you should expect to pay, and how you manage this, This is Money spoke to two financial advisers.
Aaron Banasik, independent financial adviser at Ascot Lloyd, replies:
In a world where landlords are often painted with a less than flattering brush, your plan to help your tenants onto the property ladder is very generous. However, as with all good deeds, HMRC is never far behind with a calculator.
HMRC will usually calculate capital gains tax based on the actual sale price, not the market value, providing your tenants are not 'connected persons'. This means they're not your relatives, business partners, or part of any arrangement that could be seen as a disguised gift. In short, if they're simply your tenants, you should be in the clear.
If the discount is particularly steep, or if HMRC suspects the sale is structured to avoid tax, they may challenge it and apply market value instead. So it's wise to keep records of valuations, correspondence, and the rationale behind the sale.
When it comes to CGT, you'll want to make full use of your annual allowance, which currently stands at £3,000 per tax year. It's not a huge amount, but every bit helps when you're trying to keep the tax bill down. Any capital gains that fall within your basic rate band are taxed at 18 per cent, while those that exceed it and fall into the higher rate bracket are taxed at 24 per cent.
Furthermore, if you've invested in capital improvements such as new kitchens, extensions, or anything that adds value beyond routine maintenance then those costs can be deducted from your gain before tax is calculated. Also, if you're planning to sell all three properties, it might be worth staggering the sales across different tax years to maximise the use of your CGT allowances.
Additionally, if the properties are jointly owned with a spouse or civil partner, you're entitled to use both allowances, effectively doubling your tax-free threshold and offering further scope to manage tax liability.
Ian Futcher, financial planner at Quilter, replies:
Capital gains tax is a tax on the profit you make when you sell an asset that's gone up in value since you bought it. You're only taxed on the gain – the difference between the sale proceeds and what you originally paid – after deducting certain allowable costs.
For property, this tax applies to second homes and buy-to-lets, as your main home is normally exempt through Private Residence Relief. When you calculate a gain, you can offset incidental selling costs such as estate agent and solicitor fees, as well as the cost of any improvements that have added value to the property, like an extension or new kitchen.
You can also deduct any capital losses you've made on other assets and use your annual exempt amount, which currently allows £3,000 of gains each year tax-free. After these deductions, the remaining gain is taxed at 18 per cent or 24 per cent, depending on your overall taxable income.
If the property is owned through a limited company, it's a different story – you wouldn't pay CGT personally, but the company would instead pay corporation tax on the profit. For individuals, any residential property CGT must be reported and paid within 60 days of the sale completing.
The question of whether you'll be liable to CGT when selling to your tenants at a discount is a good one, because HMRC's rules depend on whether the transaction is at 'arm's length.' In straightforward terms, if you sell a property to someone you're connected with – such as a family member – for less than its market value, HMRC will still treat the sale as if it occurred at full market value when working out your CGT bill. This prevents people from gifting or under-selling property to reduce their tax liability.
Selling to a tenant isn't automatically classed as a connected-person sale, but it can still fall into a grey area. If the discount is modest – for example, to encourage a quick sale or reward a reliable tenant – HMRC is unlikely to challenge it. However, if the discount is substantial and clearly below what you could have achieved on the open market, HMRC may argue that it isn't an arm's-length transaction and will substitute the market value for the CGT calculation.
Ultimately, you'll almost certainly have some CGT liability if the property has risen in value. If you're keen to sell below market price for personal reasons, it's worth getting advice from a specialist tax adviser who can help determine what level of discount might still be acceptable and ensure everything is reported correctly.
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