All you need to know about Capital Gains Tax on your property investment
Property investments are a great way to grow your money without the hassle of continuously moving funds to higher earning shares or bonds, for example. With profits and interest gained in any property investment, there is capital gains tax to be paid. Here, we will explain how this could potentially affect you as an investor.
What is capital gains tax?
Capital Gains Tax (CGT) is a tax on the profit you make when you sell a property that has increased in value. You are then taxed on the gain (profit), rather than the amount you receive in the sale. You do not need to pay CGT when selling your own home.
Capital Gains Tax is charged on the increase in the value of land, residential or business property. For example, if you invest in a buy-to-let property today for £250,000 and sell it in three years’ time for £300,000, you will have made a capital gain of £50,000.
This £50,000 is then liable to CGT.
What is the CGT allowance?
The UK Capital Gains Tax allowance increased for the 2020-21 tax year to £12,300 (compared with an allowance of £12,000 in the 2019-20 tax year).
Every individual taxpayer in the UK has an annual tax-free allowance for CGT. This allowance can be deducted from your total gains in a tax year. So, on the gain of £50,000 described above, the allowance would reduce the taxable capital gain to £37,700. If the property is jointly owned by two or more individuals, each person can use their annual allowance against their own portion of the gain.
Where there has been an investment using mutual funds, your allowance increases, effectively increasing the amount of profit your investment can make before you pay any tax.
What rate of tax will you pay?
The amount of tax you will pay on capital gains depends on your income tax rate in the year of sale. Any amount of the gain that is covered by your basic rate band would attract a rate of 18%. Once you are a higher or additional rate taxpayer, this rate increases to 28%.
It is important to remember that any capital gains will be included when working out your tax status for the year, which could push you into a higher tax bracket.
When will I need to pay the tax?
The rules for this have changed recently – you will need to pay any capital gains tax due within 30 days of the disposal of your property. Previously, the tax was due in the January following the end of the tax year, which often meant tax calculations were a bit of an afterthought.
For investors starting out, paying the tax bill straight away can help with planning your next purchase, as the tax bill is taken care of while you are still holding the cash proceeds from the sale.
What about other costs and expenses?
As with any property purchase, there are costs and expenses incurred, including real estate fees, stamp duty and solicitor fees.
You can reduce the amount of capital by deducting these costs and expenses from your gain. If you have made any capital improvements to your property, you can also deduct the cost of these from your gain.
How do you calculate your CGT bill?
Calculating your Capital Gains Tax bill can seem a little daunting (especially the first time you do it) and it is recommended that you get your calculation checked over by an accountant.
Using the above example, if you purchase a property for £250,000, with purchase costs of £7,500 and sell it for £300,0000 two years later with selling costs of £1,500 you will have a net gain of £41,500.
£12,300 of this £41,500 will then be deducted, as this is your annual CGT allowance, giving you a taxable gain of £28,700.
If you are on an income of £50,000 per annum, you will then be taxed at 28%. This is 28% of your taxable gain, which equates to £8,036. This final figure would be your total tax payable.
What if I decide to hold my property in a company?
If you hold your properties in a company, you will still make a capital gain when you sell a property. The current rate of corporation tax is 19%, and whilst this rate is lower than the income tax rates, the company does not get an annual allowance. Choosing whether to own your properties personally or through a company has other tax and legal implications, and for most investors starting out, holding the property personally is often the first step into investing.
More often than not, investors with large portfolios would use an accountant or financial adviser to help choose the optimum business structure, as there are extra tax charges for investors with high-value portfolios.
Will the rates change in the future?
The March 2021 Budget was expected to include an increase in rates of CGT and reduce annual allowances, but neither materialised in the Chancellor’s Speech. The annual allowance was frozen at £12,300, which is common during times of economic change like we’re currently in.
Anything else I should know?
The CGT rules for buy-to-let properties are different to the rules if you are selling a home you have lived in. If you are selling your private residence, it is usually not taxable.
There are also occasions where the sale of a property you don’t live in does not incur any CGT. An example of this is when properties are transferred between couples that are married or in a civil partnership (if the couple is not separated). However, if you are transferring properties between other family members, there are special rules which ensure that the disposals are at market value (and not cost or lower value). It is important to note that in some instances, transfers of properties can also have inheritance tax implications.
Is there anything I can do to reduce my bill?
CGT is a relatively simple tax, and common-sense planning can reduce your liabilities. For example, if you have two properties to sell, you could spread your disposals over two tax years, to take advantage of two annual allowances.
Keeping good records of your investments and any associated costs as you go along is key to making the CGT calculation as straightforward as possible. It also means you maximise your deductions when it is time to sell.
About MPP Invest
We don’t claim to be tax experts here, and we absolutely recommend you get an accountant involved with any tax issues that may arise.
What we are experts in is finding the perfect properties to invest in for you to get the very best out of your property portfolio.
If you’re hoping to expand your portfolio in the near future, take a look at our exciting investments.