Selling property: The CGT challenge

Alan Pink looks at some possible ways of reducing the capital gains tax charge on selling property.

If you look an inch below the surface of the thinking behind capital gains tax (CGT), what seems at first a simple and even reasonable tax becomes less so. 

CGT is simple, because you basically just pay tax on the difference between what you paid for the asset (together with any capital expenditure on improving it) on the one hand, and the net proceeds from selling it on the other. Deduct a small annual exemption, and then pay tax on the result at 28% for residential property and 20% for most other assets (assuming that the individual concerned is a higher rate taxpayer). What could be simpler and more reasonable than that? 

The reality, however, is that CGT is often no more than a tax on inflation. This is particularly acute in the case of property investors because, at least in recent years, property price inflation has been running at a much higher rate on average than normal inflation.

So, the result is that, if you sell an investment property which you have held, perhaps, for some years, you won’t be able to replace it with another comparable property, because some of your sale proceeds will be taken away from you by the government in CGT. 

Accountants and tax advisers are often asked by their clients, who see the inequity and practical difficulties that this causes, whether they can ‘roll over’ the capital gain into the purchase of a new property if they do so. This question often derives from a vague knowledge that there is such a relief; but it only actually applies in the situation where the property concerned is used by the owner (or his company or partnership) for the purpose of carrying on a trade. The relief simply isn’t available to property investors of the sort who make up the majority of those asking this question. The people that this article is mainly addressed to are that long-suffering class of people, i.e. the private landlord. 

So, I will look at some of the principal practical ways of reducing CGT on selling an investment property. Obviously, not every one of these will apply in all cases, but hopefully there will be situations where you will be in a position to reduce your tax significantly by using one or more of the following reliefs.

If the property concerned is residential, you may be able to bring about the situation by planning that the gain is covered, or partially covered, by main residence exemption. 

As most people know, in the ‘vanilla’ situation where a property has been your only or main residence throughout your period of ownership, any gain on selling the property will be wholly exempt from CGT. If the property has been your only or main residence for only a proportion of your period of ownership, the gain is time-apportioned and only that part corresponding to your main residence period is exempted. 

But there are further reliefs associated with this main residence relief which (at least at the moment) make the rules comparatively generous. If, at any time in your period of ownership, a property has been your main residence, you are also eligible for relief for the last 18 months of ownership, together with a further relief known as ‘lettings relief’, which can up to double the main residence exempt amount with an overall limit of £40,000, if there is a gain exposed to tax for a period where the property has been let out to residential tenants. I say ‘at the moment’ because the 18-month period is to be reduced to nine months from 6 April 2020, and lettings relief is more or less being ‘outlawed’ from that date (except for the comparatively rare situation of the owner co-occupying with his tenant).

 

The important planning point to bear in mind, always, with main residence relief is that you can choose which of two or more residences is to be treated as your exempt one. This election can be put in at any time within two years of the question needing to be determined – that is, within two years of there being any change in your total combination of residences. So, electing for a flat to be treated as your main residence, for example, which has never been your actual main residence, can save tax, even if only on the last 18 months/nine months of ownership. 

There can be a major benefit, if circumstances allow, in changing the nature of let property from ordinary assured leasehold tenancies to short-term holiday accommodation. This is because, for certain CGT purposes, furnished holiday accommodation which meets set criteria (i.e. available for short term letting for 210 days a year and actually so let for at least 105 days a year as holiday accommodation) qualify to be treated as a trading asset, such that a disposal of this, if it forms part of a sale of a ‘business’, will be eligible for entrepreneurs’ relief. 

Entrepreneurs’ relief reduces the rate of tax from the likely 28% rate that would have applied to 10%, and one of the interesting things about entrepreneurs’ relief is that these criteria don’t need to be met for the whole of your period of ownership of the property. In fact, they only need to be met for two years or more prior to the date of sale (this was reduced from a previously even more generous relief, requiring only one year’s qualifying period, with effect from 6 April 2019).

Of course, letting a property as furnished holiday accommodation is likely to be much more hassle (although this isn’t always the case), and accommodation in some areas is unlikely to be able to qualify as such. However, unless you make a large loss in income by converting in this way, the prospect of reducing your CGT by merely two-thirds must be very attractive, to say the least.

Offsetting capital losses incurred in the same or earlier tax years must seem like an obvious point to make. However, in some cases the existence of losses itself is something that the taxpayer might have forgotten about. Yet sometimes, when the question is asked, individuals can remember having made bad investments in the past (e.g. shares in companies), which became so much wastepaper. If you have anything like this which has become of ‘negligible value’, a timely loss claim now could result in a very satisfactory reduction in the CGT on a planned property sale. 

For losses which occurred prior to self-assessment in 1996, there is no time limit for establishing these losses and claiming them – provided you can come up with the necessary documentary evidence if asked. Losses subsequent to this date have to be claimed, broadly, within four years, but in the case of a negligible value claim, this can be made at any time when you still hold the asset but it is worth next to nothing.

A feature of the CGT incorporation relief rules has come very much under the spotlight recently, in the wake of a considerable rush on the part of property portfolio owners to incorporate these in limited companies. 

Incorporation relief takes the deemed ‘gain’ you are treated as making on transferring your property business to a limited company and deducts this from the cost of the shares, which the company issues to you in return for your property portfolio. But, interestingly, looking at things from the company’s point of view, the relief claimed makes no difference to the cost of the property portfolio on its acquisition. Here’s a simple example:

Solomon has a property portfolio which cost him £100,000, and which he is transferring to a newly formed company for its current market value of £1 million. The company issues shares of £1 million in return and we will assume, on this occasion, that HMRC accepts that this is the transfer of a ‘business’ and, therefore, eligible for incorporation relief. 

So, Solomon’s gain of £900,000 is rolled over against the shares, so he has a CGT cost going forward for the shares of only £100,000, despite £1 million of shares having been issued. The company, though, is treated as having acquired the properties for £1 million, and could sell them shortly afterwards for that figure without having to pay any tax.

The sting in the tail, if there is one, of this tax-free uplift to market value for capital gains purposes, is the fact that, where the company does sell any properties and turn them into cash, the cash can probably only be withdrawn by the individual from the company in taxable form.