How to reduce liabilities when selling investment property
BUYING properties for investment has led to significant gains for many people in the past 60 years, despite the recent nasty blip in the market. But what about the tax paid on your profit when you sell and how can you avoid your profits being reduced significantly by tax?
This tax on property is capital gains tax, which can eat up 28 per cent of your profits if you sell a property that you do not live in. The tax does not apply to the property you live in as your main residence.
This is because one’s main residence is exempt from capital gains tax. It does usually apply, though, to properties you buy for someone else to live in, including investment properties i.e. buyto-lets.
However, few are aware that the principal private residence relief that ensures that the typical family home is free of tax on sale lasts for three years from the date of sale.
So, imagine you live in a house for a year or two, preparing it for letting to tenants and then you move out and let it for three years. You can then sell it at the end of the three years free of capital gains tax, even if it has doubled in value.
This will work if you tell your HM Revenue and Customs office that you elect for that property to be your main residence while you live there. When you move, you elect for your new home to be your main residence.
If you do not sell the house for four years after moving out, you still count the three years of exemption you are allowed, plus the year you lived there, so that at least four-fifths of the tax is not payable, because four of the five years do not count. If the capital gains tax is £35,000 on sale (before taking into account the exemption), you would only pay tax of one fifth, which is £7,000.
Properties for investment and capital gains tax report from the Government this month says that to qualify for this three-year exemption, one has to show evidence of actual residence, so that the shorter the time one spends in the property, the more difficult it is to prove you genuinely lived there.
Usually, residence of several months is enough, provided your post comes there, your bank is given the address, your employer (if any) was told, and you actually lived there. If the period of residence is only a few weeks, the Revenue would need a very good explanation.
Expenditure on a property is also set against the capital gains tax.
What is important is that the work carried out has increased or maintained the value of the property. It is not just any expenditure, therefore. you cannot claim for getting the windows cleaned or fixing an old boiler. You can claim for an extension, or the creation of an attic room, where before there was none.
Keep a record of all expenditure, as it is necessary to submit evidence to the Revenue when claiming to reduce the capital gains tax.
If you are developing the property for let for the first time, then the cost of decorative work is allowed against the tax. This can be interpreted quite widely, so it is once again important to keep all receipts.
Expenditure of, for example, £20,000, comes off the sale price if it meets the criteria. The taxsaving would be 28 per cent of this, or £5,600.
When you sell an invstment property, there is also a personal allowance of £10,100, but you can only use this once in a tax year. For this reason, it is often advisable to only sell one buy-tolet property a year.
Also, a husband and wife, and also civil partners, can only claim their personal allowances on the same property.
There is much else to be said about capital gains tax and investment properties, but this gives you some pointers, which can be useful in planning what to buy, how to buy and when to sell.