Acquiring second homes has always been a popular investment option, and often these second homes can have substantial mortgages, and with the increasing interest rates and the cost-of-living crisis currently gripping the world some are considering what to do with their assets. It is therefore important to know the tax implications relating to the sale of second homes and how and when to report this. In this article, we discuss the considerations when looking to sell and what you can do to minimise the tax.
In the past 10 years the average house price has increased by a staggering 53% meaning that if you bought a second home in 2012 for £200,000, that property is more than likely worth more than £306,000 representing a significant gain of £106,000. It is therefore more important than ever to know that if you do sell what tax rates you will pay, can you minimise the gain in anyway, and do you have to tell anyone.
What is Capital Gains Tax?
Capital Gains Tax is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value.
Each person is entitled to an annual Capital Gains Tax (CGT) allowance which is currently £6,000 (2023/24 tax year, dropping to £3,000 in 2024/25), with any gains up to this level being treated at 0%. This can work well for couples as they can double up on allowances, so if you are planning to sell, it may be worth looking at transferring the asset into joint names first if it isn’t already held that way. If you make a gain after selling a residential property, you’ll pay 18% CGT as a basic-rate taxpayer, or 28% if you pay the higher rate of tax. If your income makes you a basic-rate (20%) taxpayer, but you have made a large enough capital gain to push you into a higher-rate tax bracket, you will pay the higher rate of CGT on the amount that takes you over the threshold.
The tax rate paid for residential properties is either 18% or 28% dependent upon whether they are a basic rate tax payer or a higher rate tax payer. Given the size of the gain mentioned previously, some of this would be at 18% and some at 28% but would ultimately depend upon your partner’s other income. The only other thing to consider with residential properties is that all gains must be reported and paid to HMRC within 60 days of sale.
Principal Private Residence Relief
You do get relief against Capital Gains Tax on your main residence called Principal Private Residence Relief (PPR) and this effectively negates your CGT to nil and is why when most people sell their only home, there is no CGT to pay. There are also certain criteria which must be met such as not having let any part of the property out (this excludes lodgers), the grounds including all buildings are less than half a hectare, and no part of the property was used exclusively for business. This is becoming a big talking point following a rise in the “garden office” being added to properties. One question to consider therefore is how to treat a property that you used as your main residence and rather than sell, buy a second property to move into and then rent out your previous property.
In this scenario you will have an element of the gain that attracts 100% PPR relief. To calculate this what we must do is calculate the total period of ownership, this begins on the date of purchase or 31 March 1982 if it was before this date. Ownership ceases upon the sale of the property, if the property has been your main residence at some point, the last 9 months of ownership will always qualify for PPR. Once the period of ownership has been calculated you are then entitled to PPR for the period you occupied the property.
As an example, if you had owned the property since October 2002 and you sell it in October 2022 you will have owned it for 240 months. We can say that you have had 9 years or 108 months whereby you had PPR, furthermore as you occupied it as your main residence at some point you are also entitled to the final 9 months prior to sale. The next step is to calculate the gain, so if we say the gain is £106,000, we will then give relief to 117/240 x £106,000 being the period of PPR plus the last 9 months. This relief being £51,675.
A period of absence
There are other things to consider in relation to properties which can have an impact upon the gain, for example an absence period. In the first 2 years of ownership, you may not be able to occupy your property as you may need to refurbish or may not have sold the previous property. It may be that you still must build the house as you only have the land which you acquired. In these scenarios the first 24 months are actual occupation when calculating the gain.
There are other reasons for absence such as working abroad, this can often affect military personnel, whereby they rent their property out whilst they are overseas. Any absence totalling not more than 3 years in all will automatically qualify as a period of absence which is allowable.
It was mentioned earlier that you can claim PPR on your property if the grounds including all buildings are less than half a hectare. If your garden and grounds exceed half a hectare, you may not be entitled to relief for all of it. The area for which you are entitled to relief is called the permitted area. It consists of the area that’s required for the reasonable enjoyment of your dwelling house as a home. The size and character of your dwelling house must be considered. For example, a 2-bed cottage is unlikely to require 5 acres of land for reasonable enjoyment whereas a 10-bed mansion may need this level of land with the property.
Understanding your situation
There are many considerations when it comes to Capital Gains Tax on second homes and it’s important that you understand the different scenarios and tax implications before making any decisions. Having the right information is key so you can make the right decision for you, and that is where your accountant comes in.
If you want to discuss CGT on additional properties or are planning a sale, get in touch using the form below.