Capital gains tax on second homes; liability & planning
More people are selling second properties. This could give rise to substantial CGT liabilities. How are those CGT liabilities calculated? Advance planning can reduce those CGT liabilities.
It would seem that some of the tax measures announced by George Osborne in his Budget in 2015 are beginning to take effect. More and more people are selling their buy-to-let investments. This naturally leads into considerations on potential capital gains tax (CGT) liabilities.
Capital gains tax is payable on the profit made from the sale of property that is not the taxpayer’s principal private residence, as well as assets such as shares (that are not held inside a pension or ISA).
Whilst no CGT is payable on the profits arising on the sale of a private residence, CGT is a reality on the sale of a buy-to-let property. After deduction of the CGT annual exempt amount, tax will be payable on the gain at 18% (to the extent it falls within the investor’s basic rate tax band) and 28% (to the extent it takes him or her into higher rate tax). It should be noted that the top rate of CGT on residential property is therefore 28% – even for 45% income tax payers.
And we can expect that HMRC is taking a keen interest in these transactions.
It has been reported that HMRC is apparently cracking down on those who sell a second home or buy-to-let property but fail to pay tax on the profits.
In this regard, apparently HMRC is to write to 1,500 people it has identified as having sold a property in the 2015/16 tax year but not declared a profit on which capital gains tax would potentially be payable. The letter will ask recipients to explain why they have not declared the gain and paid any tax. Failure to respond to the letter or provide an adequate explanation could result in a formal investigation and fines.
As mentioned earlier there has been an increase in sales of buy-to-let properties after a series of tax changes, that began to come into force in April 2016, reduced their attraction to investors.
The question is, is there any way in which the CGT tax bill can be reduced?
The tax is levied on the capital gain that arises on disposal – this is the difference between the purchase price of the property and the price at which it is sold.
Each individual has an annual capital gains tax exemption of £11,700 in 2018/19. This is £23,400 per couple where the property is in joint ownership. This, of course, is an investor’s total annual exemption and so, if the investor also has taxable capital gains elsewhere, these will count towards it. Losses from, say, the sale of shares or another property can be offset against gains.
Furthermore, the investor can deduct from the gross gain any costs incurred in the process of buying and selling the property, such as legal fees, agents’ fees and SDLT. It is also possible to deduct the cost of improvements, such as a kitchen extension or putting in a new bathroom.
It is not possible to deduct mortgage interest, repair costs or the cost of replacing items, (known as running repairs). However, in the case of buy-to-let properties, such costs will typically have been claimed against income in the year they were incurred. Matters can get complicated if an item is replaced with one of a higher specification, (in which case part of the cost can be offset against income and the other part against any gain.)
If a property has been the principal private residence of the investor for part but not all of the time it has been owned by the investor, in principle, CGT will only be charged on the pro rata gain for the period during which the property was not the investor’s principal private residence. It is also possible to claim an exemption for the last 18 months of ownership whether the property was occupied or not.
If a property that has been occupied as a private residence has been let out, it is possible to make use of lettings relief, which will reduce the gain by £40,000 — or the amount of the gain that is chargeable, whichever is lower. For investors who have more than one home that they have used as a private residence, they can nominate which will qualify for principal private residence relief. It does not have to be the one where they have lived most of the time.
Generally, it would make sense to nominate the one expected to make the largest gain when the property is sold. The problem here is that the investor needs to act quickly as they only have two years from when a new home is bought to make the nomination.
Unmarried couples can each nominate a different home as their main residence and therefore benefit from two “principal private residence” exemptions. This does not apply to married couples or civil partners.
When is the tax due
The deadline for paying CGT is the last day of January after the end of the tax year in which the taxpayer realises the gain. For example, if the taxpayer sold a property on 1 August 2017 (in the 2017/18 tax year) the deadline to pay the tax due would be 31 January 2019.
There are plans to change the rules to require tax to be declared and some paid on account on such properties within 30 days of sale. This is expected to come into force on 6 April 2020.
Example – Frank
Frank bought a house on 1 February 2006, for £120,000, lived there until 31 July 2010, and let it until it was sold on 31 January 2018 for £260,000. He will have made a profit of £140,000 over the 12 years he owned it.
He is entitled to the principal private residence (PPR) relief for the time it was his main residence — in this case, the initial 54 months. A further relief is available for the final 18 months before it was sold, allowing him to claim PPR relief for 72 of the 144 months of ownership.
Deducting £70,000 from the total gain of £140,000 (72/144ths) leaves £70,000 that is subject to capital gains tax (CGT) — assuming no other capital expenditure that could be used to reduce the gain further.
Because Frank had let the house, a further £40,000 letting relief can then be deducted, reducing the gain to £30,000. From this he can deduct the annual CGT exemption in the tax year the property was sold — £11,300 in this case — pushing the taxable gain down to £18,700.
If he were a higher or additional rate taxpayer, Frank would pay 28% tax, giving a bill of £5,236. If the gain kept Frank in basic rate tax, he would pay 18% or £3,366.