Property gains

The chancellor’s generous tax exemption for anyone selling their main home is a relief given the huge rise in property prices in recent years. If a property is deemed an individual’s “principal private residence” (PPR) then they are not liable to pay any tax on it when they come to sell.

But for those who have bought more than one property, either as a buy-to-let investment or a holiday home, selling up could incur a significant tax bill.

Property is like any other asset in that you are liable to pay capital gains tax (CGT) on any profit you make from it. Whatever you gain is effectively lumped on top of your annual earnings and in the majority of cases this will push you into the higher tax rate band. This means you will be required to pay 40 per cent on the difference between what you paid for your property and what you sell it for.

But if you are looking to sell a second property there are some opportunities for mitigating your tax bill. Although these tend to be complicated and time-consuming they can result in a dramatically different tax liability.

Can I use my CGT allowance to reduce my bill when I sell my
second property?

Yes. Every individual in the UK receives an annual CGT allowance (£9,200 for the tax year 2007/08).

If you own a property with your spouse you can both use your allowance, reducing the amount of any gain subject to tax by £18,400.

Take an example of a couple who purchased a holiday home more than 10 years ago for £100,000 and who are now selling it for £200,000. They are liable to pay CGT on the £100,000 gain but could reduce this with their combined CGT annual allowance to £81,600. Before using your CGT allowance, check if you can reduce the core liability by taking into account the cost of buying and selling the property.

What costs can be discounted?

Legal fees and stamp duty count as part of the cost of buying a property, as do selling costs such as estate agent fees.

If the couple paid out £5,000 when buying the house and £10,000 when selling, their £100,000 taxable gain (before taking any CGT allowances into account) would be reduced to £85,000 which can be further lowered by calculating the costs of any capital improvements.

What are capital improvements?

If any significant alterations have been made to the property while you have owned it the cost of these can be taken off the gain as well. Minor refurbishments such as repainting walls do not count, but expansions or remodelling work do, and can reduce your core gain.

If our couple spent £20,000 on an extension for their holiday home they can knock this off their gain, taking the total down from £85,000 to £65,000, which can be further reduced with indexation relief.

What is indexation relief and how do I calculate it?

Before the introduction of “taper relief” in April 1998, gains made from a property could be mitigated with indexation (inflation) relief which was calculated by measuring the increase in RPI. If you bought a property before taper relief began you can claim indexation relief over the period up to April 1998.

Say you bought a property two years before taper relief began, as the couple did, and RPI went up by 10 per cent over that period, you can then knock an extra 10 per cent off the gain made. This then takes our couple’s gain which is subject to CGT down to £55,000. And this gain is then liable for taper relief for the period from April 1998.

What is taper relief?

Depending on the period of ownership, the maximum that can be taken off a gain from taper relief is 40 per cent. If a property is held for 10 years then 5 per cent is knocked off the taxable gain each year after the first three years of ownership.

For our couple this takes their gain which is liable to tax down from £55,000 to £33,000.

The CGT charge the couple would then face, assuming they are both higher rate taxpayers, is £14,600 (ie 40 per cent of the £33,000 gain). If they each used up their annual CGT allowance they would have nothing to pay from the profit they made in selling their second property.

What if my property is used for holiday letting?

There are further gains to be made if you own a holiday let property, as these can claim “business asset taper relief”, which is higher than the non-business version.

There are set specifications on what constitutes a holiday let property. Broadly speaking it just has to be used for short-term lets for a good portion of the year. After only two years of ownership the chargeable gain is slashed by 75 per cent.

If you sell a holiday home and purchase another you can also defer payment until you have sold the next property.

Can I do anything to make all this easier to work out?

John Whiting, tax partner at PricewaterhouseCoopers, says that many people lose out on potential tax exemptions because they fail to keep details of improvements they make to a property.

It is a good idea therefore to get into the habit of keeping all these records along with notes on stamp duty and legal costs. It is likely that if you sell a second property you will be required to fill in a tax return. Whiting suggests sending in details by the September 31 deadline and letting HMRC work out the numbers for you.