James owns a residential property which has been let for many years and he is considering selling it but will lose a large amount of the proceeds to HMRC. What are the options for reducing his capital gains tax (CGT) bill? Head of Tax Christiaan Hansen highlights some of the options available.
James inherited a cottage from his parents nearly 20 years ago, since when it has been let to a series of tenants. It’s now worth almost £180,000 more than when he acquired it. If he were to sell it today, after taking off selling costs and his annual capital gains tax (CGT) exemption, as a higher rate taxpayer he would lose about £48,720 to HMRC in tax which would have to be paid within 60 days of completion. Naturally, he’s looking for ways to reduce the CGT bill. There are options open to him.
Gift and save
Because James is married, he can transfer a share of the property to his spouse. She is a non-taxpayer. The transfer itself is exempt from CGT but will mean a corresponding portion of the gain will be taxable on her, even though her period of ownership might be just a matter of months before the sale. This could save CGT of approximately £6,107.
Defer and save
James could defer the CGT payable and get extra income tax relief by investing in an enterprise investment scheme (EIS) company or portfolio of companies in the same or following year as the cottage sale. The gain is deferred until the EIS investment is sold. Also, when it is sold, and the deferred gain becomes taxable, the rates of CGT which apply are lower, i.e. 10% and 20% compared with 18% and 28%.
Alternatively, an investment in a seed EIS (SEIS), an EIS for start-up and fledgling companies, offers greater income tax incentives (50% of the amount invested). Plus, instead of CGT deferral of the gain there’s an exemption equal to half the investment.
For example, if James invested £100,000 (the maximum allowed) in an SEIS company, he could exempt £50,000 of the gain on the sale of his cottage. This would reduce his CGT by £14,000.
There are drawbacks with EIS and SEIS investments. You have to tie up your money to get the tax savings and the investments are relatively risky especially, SEISs.
Let and save
As James has experience of letting the property he might be happy to continue to do so for a couple of years before selling. In the meantime, he could switch from long to short-term lets, i.e. 30 days or less.
If the cottage if modestly furnished and available to rent for period of up to 30 days at a time for 210 days per year, and actually let for 105 days, it will qualify as a furnished holiday let (FHL). James needs the cottage to be an FHL for two consecutive years for any gain he makes from selling it to qualify for business asset disposal relief (BADR) assuming he’s not already used his lifetime BADR entitlement of £1 million. BADR reduces the CGT rate to 10%.
Gifting a share of the property to your spouse or civil partner before the sale can reduce the CGT payable by making use of any available annual exemption and lower CGT rate band. In addition, letting the property for short periods (up to 30 days) for two years before selling qualifies the gain for the 10% business asset disposal relief tax rate.
For further advice with similar property and CGT questions our Tax team would be happy to provide you with support and guidance, contact our Tax Department.