How to reduce capital gains tax selling property

How to reduce capital gains tax when selling property is on the mind of many property owners.

If you’ve ever accumulated any wealth, then you will no doubt have come across “capital gains tax” – a form of tax that applies to things like property, stocks and shares, and some commodities.

Capital gains tax is expensive and can make selling your home less lucrative.

It can also surprise some buyers, getting in the way of their financial plans.

What Is CGT?

Suppose, for instance, that you saved up your money to buy £10,000 worth of Apple shares.

The money you saved up from your income was already taxed under income tax rules.

Now let’s say that the price of Apple shares goes up 50 per cent.

The value of your investment rises to £15,000.

If you decide to sell at that price, you take home a £5,000 profit.

The government doesn’t tax the full £15,000 of income from the sale because you were already taxed on the first £10,000.

It only taxes on the £5,000 profit you made – additional income that you received over and above the £10,000 that you earned.

A similar principle applies to the property market.

If you paid £150,000 for an investment property and then sell it for £200,000 five years later, then you make a capital gain of £50,000.

The government will apply capital gains tax on the £50,000 as a percentage of your total profit.

Unfortunately, it doesn’t work in reverse.

If you lose money on capital, the government doesn’t pay a subsidy.

You have to take the full loss.

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Why Pay CGT And How Is It Calculated?

The reason the government charges capital gains tax is to ensure that income from capital pays tax just like income from labour.

A person who sells their time to an employer makes a “profit” from the time that they spend at work, doing their job.

Likewise, a person who forgoes consumption in the present to invest in an asset – like a house – makes a profit if the value of the asset goes up.

Some people with a lot of assets don’t need to sell their labour to make money: they can sell assets when the price is right to fuel their present consumption needs.

It would be odd if the government taxed income from labour, but didn’t tax income from capital gains.

The principle is that all income should be taxed in some form or another to ensure that the system is fair.

Capital gains tax is calculated as a percentage of the gain in the value of the asset, such as stocks, bonds, investments, cars, and real estate.

However, it’s unlikely that you’ll be charged capital gains tax on your main home if it is the only property you own and your primary residence.

The government offers “private residence relief” to people selling their main home, meaning that you’re unlikely to pay tax.

However, if you develop your home and convert it into flats, sell part of your home to a developer, use your home to operate a business exclusively, or buy a house just to sell it on, then you could face CGT.

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How Much Will I Pay In CGT?

Suppose for some reason that you have to pay CGT because you sold an asset, for instance, real estate, that is subject to the tax.

How do you go about working out how much you have to pay?

Check out this step-by-step guide.

Step 1 – Calculate How Much You’ve Earned

The amount of CGT you pay depends on your income.

If you are a higher earner and pay the top rate of income tax, you’ll pay 28 per cent on any capital gains for real estate and 20 per cent on all other capital gains.

If you don’t pay the top rate of income tax, then you’ll pay 18 per cent on any real estate you sell (besides your primary home) and 10 per cent on any gains for any other asset.

To complicate matters, you have a tax-free CGT allowance of £12,000 for the 2019-2020 tax year.

Meaning that you don’t have to pay any tax on the first £12,000 of income you make from your capital (similar to how you don’t have to pay any income tax on the first £12.500 you earn from labour).

Step 2 – Calculate Your Total Income And Subtract Your Personal Allowance

Let’s say that you are a basic rate taxpayer and earn £40,000 per year from your job.

Your taxable income, excluding any income from the sale of assets, is £40,000 minus the personal allowance of £12,500, which comes out at £27,500.

Let’s say that you sell an asset, like some real estate that is not your primary residence and make a capital gain of £30,000.

You have a personal capital gains allowance of £12,000, so you can subtract this from the £30,000 capital gain to get £18,000 in taxable income.

Step 3 – Calculate The Tax

Income tax on £27,500 at the basic rate of 20 per cent comes to £5,500. CGT on £18,000 at the lower rate of 18 per cent comes to £3,240.

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Reducing CGT On A Property Sale

As discussed, if a property is the main home, then it’s unlikely that you’ll have to pay any CGT.

However, if you list your property as a business address (and the government has a record of this), then they may demand CGT be paid when you sell.

Large homes, greater than 5,000 square metres may also be subject to CGT.

However, so long as you can prove that you didn’t buy a home just for the capital gain, the government is unlikely to charge CGT and offer Private Residence Relief.

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Minimise CGT On Inherited Property

Inheritors don’t have to pay CGT on gains made while the owner of the property/assets was alive.

They only pay CGT on the estimated increase in the value of the property between their taking ownership of it and the eventual sale.

Selling quickly, therefore, may help reduce CGT if the price is likely to rise.

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What About CGT If You Lose Money On Property Sale?

CGT is only payable if you make a capital gain.

If you lose money on a property – because of a property market slump – then there’s no money to pay. You incur a loss.

If you need CGT tax advice when selling a property, get in touch with BPC today.

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