Capital Gains Tax and second properties

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Nowadays it has all changed. CGT is being paid by people like you and me. It is becoming much more common – mainly due to the increase in home ownership and the rise of property values.

Now before you start worrying – the Chancellor isn’t trying to tax your home. The issue is other properties which you may own or acquire in the future.

When you sell the house which was your main residence then any profit made on the sale is not taxable in the vast majority of situations. Indeed nothing needs to be notified to your tax office. If you are fortunate enough to have very large gardens or grounds there could be important tax issues, and you would take advice on them prior to the sale.

The reason I say CGT is on the rise is that more and more people are inheriting properties – often when a parent dies or goes into a nursing home. This extra property could bring its own tax problems.

The parent disposing of their own home – either because they have died or moved into other accommodation – will not face a CGT bill. The house is covered by the CGT Private Residence exemption. (Inheritance Tax could however be payable where all the deceased’s property exceeds £325,000.)

The treatment of the property in your hands however is different. Typically you will already have your own house. This means that your exemption will normally attach to your home. The property which you have now acquired is a different matter.

If you acquire a property from your parents then for CGT purposes it is treated as if you bought it at its open market value. This will also be the probate value if instead you inherited a property from a deceased person.

The market value at the time you acquire the property is the starting point for your own CGT. It is always a good idea to have the property valued around the time you get it. If you haven’t sought a value before now then ask a valuer (estate agent) to estimate the value at the time your name went on the deeds. Then if you sell it 10 years later the valuation can be unearthed to work out your tax.

Once you own the property then any capital improvements which you make should be recorded, and receipts kept. These will reduce any CGT bill on the eventual sale or disposal. I mention ‘disposal’ because you might wish to gift the property to your own children. If you do this it counts as a disposal under Capital Gains Tax rules (market value again) and CGT will have to be worked out.

When you do sell the property then the cost is deducted from your sale proceeds, as is the cost of capital improvements while you owned it. (Note normal maintenance is not allowable for CGT.)

The amount of tax depends on your annual exemption and total income for the year. The annual exemption is £10,100 for 2010/11 (£10,600 for 2011/12) and gains below that will not produce a tax bill for you.

Once you go above the annual exemption then the gains will be taxed. The level of tax depends on your income. If you pay 40% or 50% tax then the gains will be at 28%. If you pay 20% tax then some of the gains may be at 18% (curiously not 20%) and then perhaps the top bit at 28%. The 28% rate kicks in just like income tax does when your combined income and gains reach roughly £44,000.

CGT calculations can be messy, and there may be tax-planning opportunities of which you are not aware. For this reason you may find the investment in some professional advice may be money well spent.

Huston’s Hint

If you get a property from a family member, whether or not you pay for it, get the market value established on paper as that’s your CGT starting cost.