capital gains tax

So many property investors forget about capital gains tax completely, only to be reminded sharply when it comes to selling their investment property. Capital gains can have a huge chunk of their profit, even resulting in you not making any money at all. Don't be caught unaware by this tax!

Understanding CGT

Understanding capital gains tax is not as difficult as you might imagine. In fact, the principles are actually quite simple. Capital gains tax is paid by individuals (or trustees / personal representatives). Companies do not pay capital gains tax; however, they do pay an equivalent sum, under corporation tax, known as chargeable gains.

Anyone who is liable for capital gains tax must declare it in their self assessment tax return. Or, if they fail to complete a self-assessment form, then the Inland Revenue must be notified by the 5th October after the relevant tax year has ended. Any amount payable to the Revenue will then normally be due by the end of January of the following year.

What is Capital Gains Tax?

Simply put, capital gains tax is paid on any gains that are made on the disposal of an asset. There are deductible expenses and allowances, as well as exemptions that tax payers can make the most of. Any capital gain is considered as part of income. Therefore, if you are being taxed at 40 percent, you will also pay capital gains, at this rate.

Calculating Gain / Loss

Firstly, take the value at disposal. If the asset is being given away then the current market value must be used. From this deduct the following:

• sales costs (this includes agents fees, advertising costs, solicitors' costs);
• purchase costs (again including solicitors' fees);
• the purchase price or the market value at the date of purchase; if the property was purchased before 31 March 1982, then you are able to use the market value at this date;
• any taper relief that is available to take into account inflation; and
• the costs of any capital improvements that have been made, since you owned the property; remember, the only expenditure that you can deduct is expenditure that you have not deducted previously.

A taxpayer does not have to pay capital gains on his or her main residence, provided that it is a permanent residence and any periods of absence do not total three years. If you own more than one property then you are able to elect which property you wish to be considered as your main residence.

Married couples are only allowed one permanent residence, unless they are separated under a court order or are permanently separated.

If you have a main residence that, occasionally, has been your main residence but has also had periods when it was rented out, or was not your main residence for some other reason, then normally the gain must be apportioned on a time basis. There is a specific relief which allows you to consider the last 36 months of ownership as being a period of main residence, when you are doing your calculation, regardless of the factual situation.

This may appear a little strange and is easiest understood by considering an example.

Consider that you have bought a property in which you live for a year, before purchasing a second property; you then decide to rent your original property. After a further three years, you decide to sell the original property. There would, in this case, be no capital gains tax to pay as you were resident for the first year and the last three years before disposal is automatically considered as a period with which it was your main residence. This is an important situation to bear in mind, as many investors opt for purchasing a new property to live in, whilst they rent out the other property. If you decide on this strategy, consider you position carefully after 3 years as, at this point, you may find that you start losing out to capital gains tax.

Another relief which may be of particular interest to property investors, is the relief that is available on property that has been a main residence, at some point, but has also been let out for a residential purpose. This relief is either £40,000 or the amount which is equal to the main residence fraction, whichever is the lower at the time of calculation.

Take a look at this example:

You purchase a flat for £200,000 which you then sell for £300,000. The gain is £100,000. If you owned the property for 5 years and lived in it for 1, you would have 1/5 which is liable for capital gains tax and 4/5 (the first year and the last 3) which is not. Therefore, the total exempted amount of the gain is £80,000 and the total taxable amount is £20,000.

The amount of the exemption that you can claim is the lower of £40,000 or £80,000 (exempted amount). Therefore, you can claim relief for £40,000. As your gain was £20,000, in this case, no tax would be payable.

And that is it, for a brief and very simplified look at the CGT reliefs, available on residential property. There are a number of special rules that apply to special circumstances such as agricultural residential property and a few other situations, but we won't go into them, here.

The annual allowance is currently £8,800 (this is reviewed annually) per person; therefore, you can make a gain of £8,800, before you are liable for any capital gains tax.

If you make a loss in any year this can be offset against gains from other sources of income in that year, or can be offset against capital gains made in future years.

Common transactional structure that save capital gains tax

The transfer of assets between husband and wife is tax free. Therefore, many couples will choose to transfer the asset to the individual who pays the lesser tax rate. By doing this, the person actually disposing of the asset can use their personal allowance and the remainder will be taxed at the lower income tax rate.

In essence, the concept of capital gains is relatively simple. Despite this, many property investors forget to consider the possible implications of this tax on their levels of profit. With a potential bill of 40 percent of any gain you have made, it is vital that you consider this tax and obtain the necessary advice, before you get stung!

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capital gains tax