Capital Gains Tax for property investors

4th November 2019 Nicky Cole
Capital Gains Tax for property investors

Property investors – reduce your capital gains tax bills

Capital gains made from the sale of residential properties are taxed at a higher rate than other gains. This is bad news if you’re a buy-to-let property investor, but there is a way you can improve the situation. What does it involve?

Higher tax rates

Residential landlords and second home owners have been at the sharp end of recent tax hikes. This includes being excluded from lower capital gains tax (CGT) rates (10% for basic rate taxpayers and 20% for higher and additional rate taxpayers) which have applied since April 2016. Gains made on residential properties remain chargeable at 18% and 28%.

Traditional tax planning

Despite the rules for taxing residential property gains at higher rates, it’s possible to mitigate CGT using tried and trusted methods. For example, by transferring a share of a property to your spouse shortly before sale to utilise their annual exemption and lower tax rate. However, the lowest CGT rate achievable is still 18%. Tip. For a more tax-efficient approach you can use the enterprise investment scheme (EIS) to achieve the same CGT rates which apply to other types of capital gain. It could reduce the rate from 18% to 10%: a 44% reduction.

How does it work?

The mechanics are straightforward, although there are practical factors to consider. By investing all or part of the gain made from selling a residential property in an EIS, you can claim a deferral of the CGT until such time as you sell the EIS investment. That could be six months or six years later. The neat trick is that filtering the gain through the EIS changes its nature from a residential property gain to a normal gain, meaning that the standard rates of CGT (10% and 20%) apply. What’s more, you can still use the traditional tax planning strategies to reduce the gain further when it’s released following the sale of your EIS investment.

Example – Jim sells his second home for £250,000 making a capital gain of £76,000. He faces a CGT bill of £17,920 (£76,000 – £12,000 exemption = £64,000 x 28%). Two months after selling his home, well within the EIS time limit, Jim invests £64,000 in an EIS and defers an equal amount of the gain. A year later he sells the investment and the deferred gain becomes taxable. Jim’s CGT exemption, say £12,000, reduces the taxable gain to £52,000, on which Jim’s CGT rate is 20%, giving a tax bill of £10,400. A saving of £7,520.

Putting the scheme into practice

EISs involve investing in small to medium-sized companies which are often high risk. Also, their availability is limited and they can be difficult to sell. However, if you’re willing to take the chance (you might even do well out of the investment), there are ways to reduce the risk and find suitable companies to invest in.

Tip – Some investment brokers offer EIS portfolios. These spread your investment between a number of EISs. This reduces your risk and increases your chance of being able to sell the investment at a time to suit you. Alternatively, if you keep an EIS for at least three years you can claim a generous income tax credit in addition to the CGT advantage.

If you would like more advice on how to save tax, give us a call!

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