How to Beat the Upcoming Capital Gains Tax Increase
Serious CGT concerns for property owners
THE NEW Government’s announcement that it intends to increase Capital Gains Tax (‘CGT’) rates to something ‘close to those applied to income’ has caused serious concern amongst landlords, property investors and other property owners.
The latest information can be found in our popular guide for property investors:
Capital Gains Tax Planning Guide
The fear is that many property sales will be taxed at rates of 40% or more in place of the current 18%; more than doubling the CGT faced by many property owners.
One of the biggest problems currently faced by property owners hoping to take action to beat the increase is the fact that we do not even know when the new CGT rates will apply from. There is a possibility that the increase may apply immediately from the date of the ‘Emergency Budget’ on 22nd June or even that it may be backdated to 6th April 2010; although it is also quite possible that the increase may not apply until 6th April 2011.
Many property owners wanting to beat the CGT increase are considering action such as selling off their properties or transferring them to family members, trusts or companies.
For those considering action of this kind, it will generally be too late to make open market property sales before the Emergency Budget on 22nd June without having to sell at a substantial discount. Transfers to family members, trusts or companies can be carried out fairly quickly, however, so it is still possible to take action before 22nd June without sacrificing part of your property’s value just to make a quick sale.
Provided that the CGT increase is not backdated, transfers of this nature will generally result in the property’s increase in value to date being taxed at 18% but should shelter the current value from the higher rates applying in future.
More Considered Responses
Not everyone wants to rush into beating the CGT increase, however. There are many good reasons to ‘sit tight’ for the time being and plan to deal with the new CGT regime when it arrives.
The first thing that all property owners need to remember is that the increase in CGT rates cannot affect them unless and until they actually make a property disposal: i.e. a sale or transfer.
If you have no plans to dispose of your property in the foreseeable future, you may have no reason to be concerned about the increase in CGT rates. The CGT increase is part of a programme to cut the current deficit: there is every reason to believe that it will not be a permanent feature of the UK tax system and that a return to lower rates of CGT in a few years’ time is a strong possibility.
The Government has stated that there will be generous exemptions for business assets. They have not stated which assets will qualify but this may include most business property, as well as furnished holiday lets (albeit perhaps with a more restricted definition). There is therefore a strong chance that the effective CGT rate on these properties will be no more than the current rate.
One of the great criticisms of the current CGT regime is that there is no relief for long-term investment: the same rate of 18% applies whether you have owned a property for one year or over 20. The new regime may see the re-introduction of some reliefs similar to those we have seen in the past, such as indexation relief or taper relief. These reliefs often resulted in the effective CGT rate on long-term investments being similar to the current 18% rate in many cases.
Residential Property
Apart from furnished holiday lettings, there may be no new reliefs for residential property under the new CGT regime.
What we can hope, however, is that the existing principal private residence relief, which applies to capital gains on your own home, will be left intact, or at least not drastically altered. This relief provides enormous scope to reduce the CGT liability on residential property if the owner is prepared to undergo the inconvenience of moving house.
Principal private residence relief is extremely powerful because not only does it exempt a property from CGT for the period during which it is the owner’s main residence but it also exempts it for the last three years of ownership. Furthermore, a property which is eligible for principal private residence relief, and which is also let out as private residential accommodation, is also eligible for private letting relief. This second relief will generally provide a further exemption equal to the lower of the amount of relief already obtained under principal private residence relief or £40,000 per person.
Example
Rory owns a rental property which he bought in 1995 for £50,000 and which is now worth £250,000. If he sold the property under the current CGT regime, he would have a capital gain of £200,000. After deducting his annual exemption of £10,100 this would leave a gain of £189,900 exposed to CGT at 18%, thus giving Rory a tax bill of £34,182.
Let us suppose that, on 22nd June, the rates of CGT are aligned with Income Tax with immediate effect. Rory is a higher rate taxpayer so he is now exposed to a potential tax bill of £75,960 (£189,900 x 40%).
The first thing that Rory does is to transfer the property into equal joint ownership with his wife Amy. The couple then move into the property and use it as their main residence for two years. After this, they move back into their previous home and rent the property out again.
Three years later, in the summer of 2015, the couple sell the property for £290,000. At this point, Amy is on a career break and her income is covered by her personal allowance.
Let us assume, for the sake of illustration, that CGT rates are still aligned with Income Tax rates and that there have been no changes to the annual exemption, the basic rate band, or the scope of principal private residence relief.
Rory and Amy will have a total capital gain of £240,000, or £120,000 each. However, each of them is exempt on five years of ownership: the two that they lived there plus the last three. The couple’s total combined ownership period is 20 years (i.e. since Rory bought the property), so they are eligible for principal private residence relief equal to 5/20ths of their gain, or £30,000 each.
This also entitles them to private letting relief of £30,000 each and each of them will also have an annual exemption. Taking all of this into account, they each have a taxable capital gain of just £49,900.
Rory pays CGT at a straight 40%: i.e. £19,960. However, Amy will only pay 20% on the first £37,400 of her gain and 40% on the remainder. This totals £12,480, giving the couple a total CGT liability of £32,440.
It’s just an example and there are a few assumptions but what this shows is that, by taking the right action, Rory was able to keep his property, benefit from a further five years of capital growth and still pay less CGT than he would have done under the current system: let alone the new regime!
In Summary
Some people may want to take speedy action now to beat the CGT increase but others could benefit by taking their time and planning a more considered response. Many properties will benefit from current or future exemptions and reliefs and a lot of property owners could be better off by planning how to get the best out of the new CGT regime rather than rushing into trying to beat it.
Basic Rate Taxpayers and Married Couples
The Government is not saying that it will increase the rate of CGT to 40% but rather is saying that it will be at rates similar to tax on income.
This suggests that a basic rate taxpayer will only pay CGT at 20%. This may be particularly useful for married couples and civil partnerships where one spouse or partner has little income of their own. By transferring property to the lower earning spouse or partner, or into joint names with them, it may be possible to ensure that up to £37,400 of the capital gain is taxed at just 20% (at current rates).
The information contained in this article on a possible capital gains tax increase is covered in detail in our popular tax guide:How to Save Property Tax by Carl Bayley
This comprehensive guide is essential reading if you're trying to pay less capital gains tax.
