Times have gotten tougher for buy-to-let investors. So much so that many have decided to exit altogether and sell down their property portfolio.
But selling an additional property is a significant financial event. There are many considerations for landlords, notably the impact of capital gains on the sale of their property and how they might supplement their income having sold a yielding asset.
The good news is that the sale of additional properties is a great opportunity for financial advisers to help clients. This article talks through a scenario illustrating how, with some clever planning, you could add real value for a client.
Tougher conditions for buy-to-let
The outlook for clients who own rental properties has progressively worsened.
Until 2017, buy-to-let landlords could deduct their mortgage interest from their rental income and only pay tax on the net income. Today, landlords only receive a tax credit equivalent to the basic rate of tax. That means higher and additional-rate taxpayers don’t get all the tax back on their mortgage interest payments. In addition, the recent hike in interest rates can make paying off a mortgage more expensive.
These are just some of the additional costs and complexities being added to the buy-to-let market.
Understandably many landlords are considering selling up and putting their money to work in a different way.
However, this has various potential implications, including tax implications. In fact, the Treasury received a record £14 billion in capital gains tax in the 2020/21 tax year with a big contributor being the sale of second homes.3
Now is a good time to speak to clients who are landlords to see how you might support them.
Bobbie currently has an additional property which she lets out to supplement her income.
However, she’s finding that income is being squeezed by legislation and being a landlord has become more burdensome.
She meets with her financial adviser and explains that she’d prefer to sell her property and do something else with the money. However, because of house price inflation in the UK over the past few years, she would realise a sizeable gain if she sold her rental property. This is made more significant by the fact Bobbie has already used her full capital gains tax allowance (£12,300) for the current tax year against another gain.
Bobbie would also miss the additional stream of rental income.
Bobbie asks her adviser what her options are.
What Bobbie’s adviser recommends
As she’s experienced in making early-stage investments such as VCTs and is comfortable making a high risk investment, Bobbie’s adviser recommends she consider making a different tax-efficient investment.
Bobbie purchased her rental property for £800,000 and its market value today is £900,000. Her adviser explains that Bobbie could sell her property and invest the portion of the proceeds which represents a capital gain – an amount of £100,000 – in a portfolio of EIS-qualifying shares.
To compensate for some of the risks involved in investing in early-stage UK businesses, the Enterprise Investment Scheme (EIS) allows investors to claim generous tax reliefs. Bobbie can claim up to 30% up front income tax relief on her investment, and she has the potential to make a tax free gain on her investment. She could also claim relief on any losses, against gains or income, should an individual EIS-qualifying company in her portfolio fail.
Critically, Bobbie could also use her EIS investment to defer the gain she crystallised upon selling her rental property. That means gains would come back into charge when the individual companies within her EIS portfolio were sold (or fail). Because EIS portfolios are a long-term investment, with companies maturing at different times within a portfolio, in practice Bobbie might be able to spread the deferred gain over several years and make use of multiple years’ capital gains allowances as it returns to charge.
Bobbie’s adviser then explains that she could invest some or all the remaining capital from the sale of the £900,000 property into a diversified portfolio of investments to target an income.
In addition to using some of the capital to top up her listed equity and bond portfolio, her adviser suggests that a Venture Capital Trust (VCT) could allow her to target a tax-free income (often targeting 5% of Net Asset Value per annum), while diversifying her sources of income.
VCTs invest in a diverse portfolio of early-stage businesses and, like EIS, VCTs also offer tax reliefs to compensate for some of the risks of investing in these types of businesses. Bobbie could claim 30% upfront income tax relief when investing in a VCT and pay no tax on any income she receives from her investment.
It’s important Bobbie understands the risks
Bobbie’s adviser stresses that EIS and VCT investments are long-term, high-risk investments.
The value of the investments, and any income from them, could fall as well as rise. Bobbie may not get back the full amount she invests.
Her adviser also explains that tax treatment depends on individual circumstances and that tax rules may change in the future. Tax relief depends on portfolio companies and VCTs maintaining their qualifying status.
VCT shares and the shares of early-stage companies may be more volatile and harder to sell than the shares of larger listed companies.
Octopus Ventures EIS Service
If you’d like to learn more about how EIS and VCTs work and how they could help your clients, you may want to look at the resources below.
Visit the Octopus Ventures EIS webpage
Visit the Octopus VCT webpage
Learn how EIS works and the tax reliefs available
Learn how VCTs and the tax reliefs work
About this scenario
This planning scenario is designed to help advisers like you develop appropriate planning strategies for your clients. Nothing here should be viewed as advice. Any suitability decisions should be based on a comprehensive review of your clients’ objectives, needs and attitude towards risk.
 The Telegraph, Landlords warn wave of evictions to come, July 2022
 This is Money, Will this spark a buy-to-let rush for the exit? December 2021
 The Telegraph, Landlords running scared of regulation, August 2022