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How to avoid the capital gains tax trap when downsizing

by | Dec 3, 2021

Homeowners can be liable for capital gains tax if they move out early. Record house prices and a surge in demand for detached family homes mean many downsizing older homeowners will receive enormous windfalls when they sell up.

But the cash generated could be considerably less than they banked on. A capital gains tax trap means downsizers could have to unexpectedly fork out thousands of pounds if they move out of their properties before they sell.

How are downsizers being caught out?

Homeowners are not required to pay capital gains tax on their “main” residence, because they will receive private residence relief.

Homeowners can nominate their main residence within two years from the date when they first acquired the additional property. They must nominate the property in which they spend the most time.

If they do not nominate a main residence, the taxman will decide which property qualifies, based on a series of factors. These include where the owner is registered to vote, where their vehicle is registered and where their children have attended school.

But people who leave their main property to live somewhere else can find themselves in a tax trap.

If the property has been a person’s only or main residence at some point, the last 18 months of their period of ownership are not liable for CGT. But beyond this, the property is considered an additional home, meaning it ceases to qualify for private residence relief.

This means that people effectively have an 18-month period to sell their original home before the property starts to become liable for CGT.

For disabled people, or people resident in care homes, the final 36 months of their ownership will be tax free (on the condition that they do not have another private residence).

How is CGT calculated after this cut off?

To work out your potential liability, you need to compare the amount you initially paid for the property with the amount you are likely to get when you sell it.

The cost of any improvements made to the property while you owned it, such as a new bathroom or conservatory, should be added to your initial outgoings, as should stamp duty and legal fees.

You can deduct expenses like solicitor’s fees from the selling price – use the amount of money which you end up receiving.

Your gain is the difference between your costs and what you will get when you sell. This will then be taxed in proportion to the period when the property was no longer your main residence, minus the final 18-month tax-free period.

What does that mean in cash terms?

For example, if you spent £300,000 buying your property in January 2000, including stamp duty and fees, and paid for £100,000 worth of improvements, your spend was £400,000.

If you then sold the property in December 2020 for £1m, after fees have been deducted, your capital gain was £600,000.

If you had moved into a new house two and a half years before you sold your original property, you would be liable for tax on 12 months’ worth of that gain.

In total, you owned the property for 252 months. So, divide 12 by 252, and multiply this figure by £600,000. In this situation, you would be liable for tax on £28,571.

For every tax year, you have a CGT allowance of £12,300, which you can deduct from your taxable gains for that year. If the sale of your property was your only source of capital gains in that year, this would reduce your liability to £16,271.

How much money would you pay?

The rate of CGT you pay on this remaining taxable gain would then depend on your other income for that year.

If you were a basic-rate taxpayer and the amount kept you within the basic income tax band, your gain would be taxed at 18%. In this case, that would mean a total charge of £2,928.

If the amount meant you exceeded the basic tax band and became a higher-rate taxpayer, the difference would be charged at 28%.

If you were already a higher-rate taxpayer, all the gain would be taxed at 28%. In this case, a total charge of £4,556.

Adapted from an article on The Telegraph by Melissa Lawford


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