Since April British investors enjoy some of the lowest capital gains tax (CGT) rates among developed nations, following the decrease from 18% to 10% and from 28% to 20% for basic and higher rate taxpayers, respectively. However, this does not apply to residential property where the old rates (18% or 28%) still apply. Property taxation has been a sensitive issue in the last years due to the large number of taxpayers affected, large amounts of money (and tax) involved and Britain’s notorious housing shortage. As a result, the rules are quite complex and hard to understand to many. Let’s put some clarity into them and their implications for your financial and tax planning.
How CGT Works for Most Investments
When you sell investments such as shares or funds (held outside a tax wrapper like a pension or ISA), your gain (selling price less purchase price) is subject to CGT of 10% (if you are a basic rate taxpayer) or 20% (if you are a higher or additional rate taxpayer).
There is an annual CGT allowance, which is independent of (in addition to) your personal income tax allowance and lets you earn the first £11,100 (for 2016/17) of capital gains tax-free. Beyond that amount the CGT rates apply.
The general mechanism is the same with residential property, but there are a few specifics worth knowing.
The rates remain at 18% and 28% – effectively there is now an 8 percentage point surcharge on capital gains made on residential property vs. other investments. When announcing the changes in the 2016 Budget, the former Chancellor George Osborne stated that the intention was to create an incentive for people to invest in businesses (and help grow the economy) rather than property (and help grow property prices).
The CGT allowance applies to property in the same way as to other investments. Therefore, if you have made capital gains on both property and other investments in a given tax year, it makes sense to first use the allowance on the property portion to save a higher amount of tax.
With property there are generally more opportunities to deduct costs when calculating taxable gains. You can deduct transaction or administrative costs such as estate agent’s and solicitor’s fees. You can also deduct the cost of improvements which increase the value of your property, such as extensions, but not the cost of regular maintenance or decorations.
Private Residence Relief
If you are selling your own home (“your only or main residence”), or part of it, chance is you won’t have to pay CGT. This is covered by the so called Private Residence Relief. The rules what qualifies are quite complex, but the key points are the following:
You must have lived in the property the entire time, with some exceptions, such as a short period at the beginning (to allow time to prepare the home and move in) or when you had to live elsewhere due to employment duties.
It must have been your main residence. Second or holiday homes don’t quality and are always subject to CGT. Also note that if you are married or in a civil partnership, you can’t have a different “main residence” than your partner, unless you are separated.
It can be a house, flat, houseboat or fixed caravan.
It also includes the grounds, such as a garden and any buildings on it, but not larger than the “permitted area” (0.5 hectares or 5,000 m2 including the buildings). Any part beyond that does not qualify for the relief.
Any part of the property must not have been used exclusively for business purposes at any point of your ownership period.
You have not let part of the property to others at any time, except when having a single lodger.
You can find detailed official information, as well as some examples, on gov.uk.
CGT Liabilities for Non-Residents
Keep in mind that being an expat or non-resident in the UK is no longer a way to avoid CGT duties. Since April 2015 British expats and non-residents who have sold or disposed of UK property are required to report this to HMRC and CGT is payable on gains made after 5 April 2015.
You must inform HMRC even if there is zero tax to pay. The deadline is quite harsh – 30 days after the ownership transfer date.
Taxpayers often underestimate the importance and potential of CGT in their tax planning. Unlike regular income, such as salary, you often (though not always) have more control over the timing of your investment sales and which tax year the particular capital gains are attributed to.
The first rule is to try to use the CGT allowance in full every year.
The second rule is to take advantage of tax wrappers like pensions or ISAs, or other ways to reduce or defer your CGT liability, depending on your circumstances.