How Your Children Can Save You Capital Gains Tax
Use Your Children's CGT allowance and PPR
AS SOON as your children reach the age of 18, they are each entitled to their own principal private residence for Capital Gains Tax purposes. This provides enormous potential for either parents or their children to enjoy tax-free capital growth on property occupied by young adult children. Many families use the young adult’s university years as an opportunity to cash in on this benefit.
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How to Save Property Tax
As most readers will know, a principal private residence is exempt from Capital Gains Tax. However, the principal private residence exemption goes a lot further than most people realise. Not only does it exempt the property from Capital Gains Tax whilst it is being used as the owner’s main residence, it also provides exemption for the last three years of ownership. The exemption works on a ‘time-apportionment’ basis, so living in a property for a year will generally provide four years worth of exemption.
On top of all this, any property which is the owner’s main residence at any time during their ownership and is also rented out as private residential accommodation is also eligible for private letting relief. This relief effectively doubles the principal private residence exemption in most cases, although it is subject to a statutory maximum of £40,000.
Example
Patrick’s daughter Joanna is about to start a three year degree course at Purdey University. Patrick gives Joanna £80,000 as a deposit on a four bedroom townhouse and acts as guarantor for the loan Joanna needs to make up the rest of the £150,000 purchase price.
Joanna moves into one room in the property and rents out the other three bedrooms to friends, using the rental income to fund her mortgage repayments. The four friends share the same kitchen, dining room and living room, so they effectively live as a single household.
Over the next three years, Joanna’s tenants come and go and she moves rooms several times, so that she has used each room at some point. At any given time, Joanna is personally using all the common areas (the kitchen, etc) and one of the bedrooms. In this particular case, this amounts to 60% of the property’s total floor space.
After graduating, Joanna moves to London and rents her old house out to different groups of students for another five years, before finally selling the property for £280,000.
Capital Gains Tax
In our example, Joanna has made a capital gain of £130,000 over a period of eight years. For three years, she occupied 60% of the property as her own main residence, giving her exemption for £29,250 of her gain (£130,000 x 3/8 x 60%). She is also exempt for her last three years of ownership. Because she personally used every room in the house at some time, she does not need to restrict this part of her claim and it therefore amounts to £48,750 (£130,000 x 3/8). Joanna’s principal private residence relief therefore totals £78,000.
Joanna can also claim a further £40,000 in private letting relief, bringing her total relief to £118,000 and leaving her with a taxable gain of just £12,000. Hopefully, in eight years’ time, this should be covered by her annual exemption (currently £10,100), meaning that Joanna has enjoyed £130,000 of tax-free capital growth.
Joanna did very well here, partly because she personally used every room in the property at some time. Opinion is divided on the exact consequences of not personally using part of the property but the best advice must be to make sure the owner does personally use every room. This personal use could be quite minor, like storing some personal belongings in the room during vacations, or allowing the owner’s visiting parent to use the room whilst the tenant is away.
For a smaller property shared with only one other occupant, there would generally be no restriction on the owner’s principal private residence relief for a room not used personally.
Rent-a-Room Relief
For the three years she lived in the property, Joanna would be entitled to claim rent-a-room relief to exempt the first £4,250 of her annual rental income from Income Tax. This is because she and her tenants lived as a single household. Sharing a common kitchen and/or dining room is the usual indicator for this.
Rent-a-room relief is effectively optional. If Joanna’s rental profits calculated under normal principles (i.e. after deducting mortgage interest, etc) come to less than her total rental income minus £4,250, she would be better off not claiming the relief and using the normal basis instead. She can make this choice on a year by year basis by making the appropriate election within twelve months after the 31st January following the relevant tax year.
Keeping the Wealth
In our example, Patrick gave the deposit money to his daughter, but some parents prefer merely to lend it to their child. Whether this is for financial reasons, to be fair to siblings, or for some other reason, the same Income Tax and Capital Gains Tax savings can still be achieved.
One thing the parent generally should not do though is own the property themselves. You can lend money to your child, give it to them, or act as a guarantor on a loan but, with one important exception, the child must own the property to benefit from the principal private residence exemption and private letting relief.
Some parents prefer to keep the capital growth in their child’s student home for themselves, or at least defer the day that the child gains control of the underlying wealth until they are perhaps a little more mature. Ideally, the parents would still like to benefit from the tax-free capital growth provided by their child’s principal private residence exemption without giving a large slice of the family’s wealth to the next generation prematurely. Amazingly, thanks to that ‘one important exception’, they can.
Triple Savings
There may be some useful alternatives, but one of the best ways to maximise the tax benefits of your own child’s student accommodation is to simply give them all or part of the purchase price so that they can buy the property themselves, just as Patrick did in our example.
After seven years, the gifted funds will be exempt from Inheritance Tax, thus producing a fabulous ‘triple saving’ on your child’s student accommodation: Capital Gains Tax, Income Tax and Inheritance Tax.
Look at Patrick and Joanna. As a family, they may have saved up to £23,400 in Capital Gains Tax (£130,000 x 18%), £5,100 in Income Tax (£4,250 x 3 x 40%) and £32,000 in Inheritance Tax (£80,000 x 40%): a total family tax saving of over £60,000!
All this on top of the additional saving in rent during the child’s university years: how’s that for first class degree tax planning!
The information contained in this article on how your children can help you pay less CGT is covered in detail in our popular tax guide:How to Save Property Tax by Carl Bayley
