Reducing CGT On Residential Property Disposals

Alan Pink considers ways of reducing the swingeing 28% tax rate on gains on residential properties.

When George Osborne was Chancellor, one of his main anxieties seemed to be the booming residential property market. He took a number of fairly draconian steps to cool this market down, which indeed seem to have been successful. These included a large hike in stamp duty land tax, imposing the ’annual tax on enveloped dwellings’, making non-residents liable to capital gains tax (CGT) on UK residential property for the first time, and bringing UK residential property into the inheritance tax net even where this was held via offshore ‘envelopes’ by non-UK domiciliaries. 

It was, therefore consonant with this that, when reviewing the rates of capital gains tax (CGT), residential property was put in the top bracket of 28%. This compares with the 20% rate which applies to most other types of assets. 

The use of CGT as a short-term political device to manipulate our behaviour seems, incidentally, to have been endemic. The tax was at 30% when it was first introduced, and so remained for a great many years until Mrs Thatcher’s government changed the rate to the same as the marginal rate of income tax – the top rate at that time being 40%. Fast forward only a few years and you have Gordon Brown’s ‘taper relief’, which seemed to be the beginnings of a faintly conceptual theory behind taxation, under which more short-term gains were taxed at a higher rate. At the same time, indexation allowance, which had been introduced to avoid CGT being merely a tax on inflation, was abolished; with the rationale apparently being that, with a much lower rate of tax, it was a fair exchange. Now, the rate of tax has gone up again (surprise, surprise); indexation allowance has not been re-introduced. So, we are back into paying tax on inflation which, in the case of residential property, could be fairly described as rampant property price inflation. 

The first idea for reducing the effective rate of CGT involves planning at an early stage. So, if you’re looking down the barrel of a gain which has already arisen, you probably need to skip this bit and go on to the ideas discussed further below. However, if you’re at a very early stage in ownership of a residential property investment, or even are considering how to structure its purchase, planning for the ultimate CGT bill when it comes to be sold could pay huge dividends. 

Key to this sort of planning is spreading the ownership of the asset amongst a number of people, in order to take advantage of the fact that everyone has a CGT annual exemption (currently just over £11,000), and the 28% rate applies, also, to those who are in the higher rates of income tax. If you involve somebody in ownership of the residential property who is not a higher rate taxpayer, then you could end up with some of the gain being taxed, at least, at the 18% rate – which applies currently to individuals whose income plus gains are less than the basic rate limit (£33,500 for 2017/18) or, if the gain takes them over this level overall, to the part of the gain which is deemed to be within the basic rate band. 

The most basic form of this planning is to spread the ownership between spouses, civil partners, or cohabiting partners. They all have, potentially, annual exemptions and lower rate bands to be utilised. More ambitiously, consider a property investment limited liability partnership (LLP) in which there is a wider membership; for example, members of a ‘nuclear family’ of mother, father, and children. Interestingly, the children do not, technically, need to be over 18, but can be brought into a share of the overall gain and thereby have their annual exemptions available to offset. A family of mother, father, and three children could therefore make a gain, within such an LLP, of as much as £56,500 without any tax falling due. 

Let’s assume, though, that the person asking the question ‘how can I pay less than 28% tax on the sale of a residential property?’ has not planned ahead in this way but already owns the property, which is now standing at a capital gain. So, it’s too late, really, to consider transferring the ownership amongst family members because to do so would itself trigger capital gains – if, by way of gifts, these gains would be based on a deemed disposal of the properties at their current market value. 

One possible avenue of escape is to see if you can fit the property into the furnished holiday letting (FHL) criteria. Even if the property is currently let on a more ordinary assured six-month shorthold tenancy agreement, it is possible, if it is in the right sort of location, to change the way you exploit the property. If you meet these FHL criteria and have met them for at least one year at the date of the disposal, then the property becomes a trading asset for the purpose of CGT. The criteria are that the property is let as holiday accommodation for at least 105 days in the year, and is available for such letting for at least 210 days. None of the individual lettings must be more than 31 days. 

Of course, running holiday accommodation of this sort is a completely different kettle of fish, practically speaking, from being an ordinary buy-to-let landlord. There is an awful lot more active input, including cleaning, changing sheets, etc., although all of this can be done on your behalf by an agent. More fundamentally, the likelihood of making an annual profit is generally less, landlords find, where the property concerned is FHL than with a normal letting. 

However, the benefit of being categorised as a trading asset means, amongst other things, that if it has qualified as a trade in its own right for at least 12 months, the sale of the property is eligible for entrepreneurs’ relief. Entrepreneurs’ relief reduces the effective CGT rate to 10%, only just over a third of the rate of tax you might have been paying. 

Another trading CGT relief is rollover. If you sell a property which has been used as a FHL during your period of ownership, and acquire another trading asset of any kind within the rollover relief criteria, some or all of the gain can be rolled over into the acquisition of the new asset, and tax wholly or partially deferred – perhaps for a very long period. Unlike entrepreneurs’ relief, though, a tally is kept of how much of the period of ownership of the property has been of a trading description (FHL) and how much has been ordinary letting - and the amount eligible for the rollover relief is scaled down accordingly. 

Even if the property concerned has never been a residence of yours there is, at least theoretically, the possibility of securing this status for it for a proportion of your period of ownership, and thereby reducing the amount of tax payable on the sale. 

Even a short period of occupation as a residence can bring about significant tax reductions because of the availability of the last 18 months’ relief (which applies in all circumstances where a property has been your main residence at any time in your period of ownership); ‘letting relief’ of up to £40,000, or the amount which is exempt under the normal provisions if less, which can apply to periods of ownership that would otherwise be taxable because the property has been let as residential accommodation to tenants; and, of course, an allowance for the period of occupation itself if this is not in any event part of the last 18 months.

The property doesn’t have to be your actual main residence. Providing it is a residence of yours, perhaps a second or third home, you can apply, at any time within two years of the date on which it becomes necessary to determine which of your properties is your main one, for it to be treated as your main residence for tax purposes. What you are saying by putting in this claim is not that you are pretending that the property concerned is your main residence – if anything, it is the opposite of this. You are saying that the property is not your main residence, but you want it to be taxed as if it were.