What are the capital gains tax implications when selling an HMO?

Selling a House in Multiple Occupation (HMO) property in the UK typically triggers a liability for Capital Gains Tax (CGT). This tax is applied to the profit, or ‘gain,’ you make from the sale, not the total sale price. Understanding how HMRC classifies your HMO property—as a standard investment or a qualifying business—is crucial, as this classification dictates the available tax reliefs and the final tax bill.

What are the Capital Gains Tax Implications When Selling an HMO?

As an expert property investor in the UK, navigating the capital gains tax implications when selling an HMO requires careful planning and precise calculation. CGT is complex, and the specific structure and management of your HMO will significantly impact your final liability.

HMO properties, while providing distinct advantages in terms of rental yield, are usually treated by HMRC as residential property investments. This classification is key because residential property gains are taxed at higher rates than gains on other types of assets.

Understanding Capital Gains Tax (CGT) on Property

Capital Gains Tax is charged on the profit you make when you sell or ‘dispose of’ an asset that has increased in value. For property sales, the gain is calculated simply: the sale proceeds minus the original cost and certain allowable expenses.

Calculating the Taxable Gain

The foundation of your CGT calculation is determining the net gain. This calculation requires three core figures:

1. The Disposal Value: This is the price you sold the HMO for (the gross proceeds).
2. The Acquisition Cost: This includes the original purchase price of the property.
3. Allowable Expenses: These are costs incurred during ownership that can be deducted from the gain before tax is calculated.

What Expenses Are Allowable?

To reduce your taxable gain, you can deduct specific costs. These typically fall into three categories:

• Acquisition Costs: Stamp Duty Land Tax (SDLT), legal fees (solicitors), and surveyor fees paid when you bought the property.
• Capital Improvement Costs: Money spent on genuine structural improvements that add to the property’s value (e.g., extensions, new bathroom suites, major roofing work). Routine maintenance and repairs (like painting or fixing a leaky tap) are usually covered by Income Tax deductions and cannot be deducted again for CGT.
• Disposal Costs: Estate agent fees, solicitors’ fees, and valuation costs associated with the sale.

Current CGT Rates for Residential Property

For the purposes of CGT, HMOs are generally classed as residential property, subjecting the gains to specific tax rates. These rates depend on your total taxable income for the tax year in which the sale occurs:

• Basic Rate Taxpayers: Pay 18% CGT on the residential property gain.
• Higher or Additional Rate Taxpayers: Pay 28% CGT on the residential property gain.

Crucially, the gain itself is added to your annual income to determine which rate band the gain falls into. If the gain pushes you over the basic rate threshold, part or all of the gain may be taxed at the higher 28% rate.

The Annual Exempt Amount

Every individual is entitled to an Annual Exempt Amount (AEA) for CGT. Any total gains realized across all assets during the tax year, up to this amount, are tax-free. You should check the current AEA for the relevant tax year as this allowance has been subject to recent reductions.

Navigating Reliefs: Business Asset Disposal Relief (BADR)

A significant implication for HMO landlords is whether the property qualifies for Business Asset Disposal Relief (BADR), previously known as Entrepreneurs’ Relief. BADR is highly attractive as it reduces the CGT rate on qualifying business assets to just 10%.

Do HMOs Qualify for BADR?

In most standard cases, an HMO will not qualify for BADR. HMRC generally views simply owning and renting out property—even multiple units—as an investment activity, not a trading business.

To qualify for BADR, the property operation must be considered a ‘trading business’. This typically requires the landlord to provide extensive services beyond standard maintenance and rent collection, such as significant cleaning, meals, or other substantial active management duties that go above and beyond those expected of a typical buy-to-let landlord.

If you believe your HMO operation qualifies as a trade, it is essential to seek professional tax advice immediately, as the criteria are strictly applied by HMRC. For the vast majority of HMO landlords operating standard leases, BADR is unlikely to apply.

Principal Private Residence (PPR) Relief and Lettings Relief

PPR relief exempts you from CGT if the property was your main home. If the HMO was previously your primary residence and then partially rented out, you may be able to claim partial PPR relief for the period you lived there.

Lettings Relief was historically available when a property that once qualified for PPR was rented out. However, since April 2020, Lettings Relief has been heavily restricted and now generally only applies if the owner was still in shared occupation with the tenant during the letting period. This relief is seldom relevant for purpose-built HMOs.

The 60-Day Reporting Rule

When you sell residential property in the UK (which includes HMOs) and realize a capital gain, you are required to report this gain to HMRC and pay the estimated CGT liability within 60 days of the completion date. This is a critical requirement that is often overlooked.

Failure to report and pay the tax due within the 60-day window can result in penalties and interest charges. You must use the “UK Property” account service to report these gains online. This payment is separate from your annual self-assessment tax return, although the gain must also be included in your full annual return.

For comprehensive guidance on these regulations, it is advisable to consult the official information provided by HM Revenue & Customs (HMRC) on Capital Gains Tax when selling property. You can find detailed rules and rates on the official government website: GOV.UK guidance on tax when selling property.

People also asked

What is the difference between capital expenditure and revenue expenditure for CGT?

Capital expenditure involves spending that improves the property’s value or useful life, such as building an extension or a significant upgrade, and is deductible against the final gain for CGT purposes. Revenue expenditure covers routine maintenance, repairs, and running costs (like minor repairs or utility bills), which are generally deductible against rental income for Income Tax purposes but not against the capital gain.

Can I deduct mortgage interest paid on the HMO against the capital gain?

No. Mortgage interest payments are an allowable expense against rental income for Income Tax purposes (subject to current restrictions on finance costs relief) but they are not considered part of the acquisition cost or capital improvement costs, so they cannot be deducted from the capital gain when calculating CGT.

If I sell the HMO at a loss, can I claim that back?

Yes, if you sell your HMO for less than its original purchase cost plus allowable expenses, you have realized a ‘capital loss’. You can report this loss to HMRC and offset it against any other capital gains you make in the same tax year, or carry it forward indefinitely to offset gains in future tax years.

How does inflation affect the CGT calculation when selling an HMO?

Inflation (known as indexation allowance) was historically used to adjust the purchase cost for the effects of rising prices, thereby reducing the taxable gain. However, indexation allowance was frozen for assets held by individuals from April 2008, meaning it is no longer factored into the CGT calculation for non-corporate landlords selling residential property today.

Is CGT calculated differently if the HMO is owned by a limited company?

Yes. If the HMO is owned within a limited company structure, the company does not pay Capital Gains Tax. Instead, it pays Corporation Tax on the profit made from the sale, which is generally payable at the prevailing corporate tax rate at the time of disposal.

Key Planning Considerations Before Selling

Before proceeding with the sale of your HMO, careful planning can help manage your CGT liability effectively:

• Timing the Sale: If you are married or in a civil partnership, transferring a share of the property to your spouse before the sale is often done to utilise two Annual Exempt Amounts, provided the transfer is genuine and takes place before the binding contract for sale is signed.
• Utilise Losses: Ensure you have accurately recorded any capital losses from current or previous tax years, as these can be used to reduce your taxable gain.
• Review Allowable Costs: Meticulously review all historic expenditure to ensure every possible allowable expense, particularly those related to capital improvements, is included in your calculation.

Due to the complexities surrounding the classification of HMOs, the availability of reliefs, and the strict 60-day reporting requirement, consulting a qualified chartered tax adviser is always the safest course of action to ensure compliance and optimise your tax position.