How to Avoid Capital Gains Tax When Selling Your Property
Below you’ll find a comprehensive guide explaining what CGT is, and under what circumstances you can avoid paying it when selling property.
Table of Contents
What is Capital Gains Tax?
According to the UK Government…
CGT is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive.
The theory is that the money you used to purchase the asset was already subject to taxation at some point, which is why the government only taxes the difference after the sale.
So, for instance, imagine you bought an asset for £10,000 and sold it for £15,000. As a result of the sale, you’ll have made a profit of £5,000. The government will not tax you on £15,000. Instead, the CGT will kick in for the gain that you made, which is £5,000.
The UK defines disposing of an asset as:
- Giving the asset away as a gift
- Selling it
- Transferring it to another party
- Receiving compensation, such as in the form of an insurance payment
- Trading or swapping for another item
Additionally, the government requires you only to pay the capital gains tax if the gains you make throughout the year on a sale exceed what is known as the Annual Exempt Amount (AEA). The tax-free allowance is £11,700 for individuals and £5,850 for trusts. Keeping your profits below this threshold is an excellent way to avoid capital gains tax on property.
The tax-free allowance has also increased over the past couple of years.
- In 2017-18, the limit was 11,300 pounds.
- In 2019-20, the rate increases from £11,700 to £12,000.
Knowing what the threshold is going into the year allows you to make strategic decisions when selling an asset. You should also be mindful of the couple’s allowance rate, which is £23,400 in 2018-19 and £24,000 the next year.
Lastly, this guide will primarily focus on the best ways to avoid capital gains tax on property, but it’s worth mentioning that the CGT can apply whenever you sell a wide range of assets. For instance, practically all personal possessions worth £6,000 or more, besides your car, are subject to the tax. The tax also applies to business assets and shares not contained in a PEP or an ISA.
When Must You Pay the CGT and What Are the Rates?
You are required to pay capital gains tax on any property that is not your main home. The government will also make you pay the tax on your main home under specific criteria.
If the house is rather large, was used for business, or has been let out, then avoiding capital gains tax on the property could be challenging.
Additionally, the CGT rates on the property are higher than the asset rates.
A primary ratepayer will need to pay a ten percent CGT rate on all assets. However, the same individual would need to pay a CGT rate of 18 percent on all property.
There is also a higher additional payer rate for both categories. The additional-rate payer will need to give a CGT of 20 percent on assets. However, the higher-rate payer would need to pay an astounding 28 percent CGT on a property.
How Much Will I Pay in Capital Gains Tax?
When searching online, you will likely come across a capital gains tax on property calculator. The formula that these calculators use is primarily the same.
We’ve taken the time to provide you with the method used for a capital gains tax on property calculator so that you can estimate how much you’ll need to pay next year.
First, you’ll want to know your income. You will either be subject to tax at the basic rate or the higher additional rate-payer.
If your income defines you as a basic-rate payer, you could make enough on capital gains tax to push you into the additional-rate payer category. If this is the case, you’ll only pay the 28 percent tax on the amount that takes you over the threshold.
In addition to your primary income, you’ll also want to calculate how much you’ve earned from other sources, such as your pension. The income that you use to determine your CGT should be a combination of all the revenue you’ve collected throughout the year. Once you have your total revenue, you can deduct your tax-free personal allowance. For example, well use an income of £50,000.
The tax-free personal allowance is different than the tax-free CGT allowance. You will need to deduct both the tax-free personal allowance the tax-free CGT allowance from the profits you’ve earned. The tax-free personal allowance is £11,850 for the 2018-19 tax year. Although the amounts are similar, this is not the same as the 11,700 CGT allowance.
Deduct the tax-free personal allowance from your gross income. In our example, we’ll subtract £11,850 from £50,000. This leaves us with a net taxable income of £38,150. Next, you’ll need to add the profits that you made from capital gains. Let’s say you’ve earned £15,000 in capital gains profits throughout the last year.
However, remember that we can deduct the tax-free CGT allowance of £11,700 from the gross capital gains profits. In this case, subtracting £11,700 from £15,000 nets us with £3,300 pounds of profits that are subject to capital gains taxes. Add £3,300 to the net taxable income of £38,150 for the total payable amount. For our example, this comes out to £41,450 pounds.
The higher-rate threshold in the UK is £46,350. This means that the individual in the example is subject to the 20 percent tax. Multiply the total gross income times the tax rate to determine how much you’ll owe in taxes. In this case, £46,350 times 20 percent is equal to £9,270. That is how much the individual will owe in taxes at the end of the year.
Avoiding Capital Gains Tax on a Property Sale
The UK defines a few scenarios that make avoiding capital gains tax on a property sale possible. This is primarily the case when a resident sells their home. Residents must meet all criteria to avoid the capital gains tax on a property sale. First and foremost, the house that the resident is selling should be the primary residence. It must be the only home that the resident has.
The home that the resident is selling should have served as the primary home for the entire time that he or she has owned it. Additionally, the owners should not have let part of it out to others, although this component does not apply if there is a single lodger in the home. Furthermore, owners should not have used part of the house strictly for their business.
This part, in particular, could become more challenging over the years, and loophole to avoid capital gains taxes could grow smaller. That’s because more and more people are beginning to work from home or start their own business. When doing so, they may list their home address as their business address. If the government has a record of this, it will require the homeowner to pay CGT upon selling the house.
Furthermore, the entire property must be less than 5,000 square metres. This not only includes the buildings on the property but the grounds themselves. Those who live in the countryside and own substantial land could find themselves subject to the CGT unless they choose to sell the land separately from the home.
Lastly, homeowners must be able to demonstrate that they didn’t buy the structure merely to make a gain. For those who have lived in the unit for years to declare it as their primary residence, this should not be a problem. However, this component could become problematic for those who flip homes. If you purchase a home as a fixer-upper or as an investment, you’ll likely have to pay CGT upon sale.
The government says that if homeowners meet all of the above criteria when selling a home, they do not have to do anything. They’ll receive a tax break, known as Private Residence Relief, automatically. However, if you don’t meet all of the above criteria, avoiding the capital gains tax could become more difficult, and you should prepare yourself to pay the fee at the end of the year.
Avoiding Capital Gains Tax on Inherited Property
Another time when the capital gains tax comes into play is when an individual inherits property. Often, the individual who inherits the property does not want to deal with the burden of keeping it. The good news is that if the individual chooses to sell the home immediately, they may not find themselves subject to the capital gains tax.
The deceased’s estate does not have to pay CGT on any property or assets not sold before they passed away. The government considers these to be unrealised gains but does not require inheritors to pay a CGT. However, if the value of the property increases after the person dies, then an individual will need to pay CGT when sold during probate.
The capital gains tax is not on the final sale price minus the initial buying price. Instead, the government estimates the CGT based upon how much the value of the home increased after the person passed away. Those who inherit property do so at the probate value. The government only holds them liable to pay CGT on the increase in probate value.
So, if an inheritor knows that they do not want to keep the inherited property, they should sell it during probate. The increase in value that occurs during probate is minimal if any at all. Selling the property during probate is an excellent way to avoid capital gains tax on inherited property, considering that the government waives previous CGT as unrealised gains.
Avoiding Capital Gains Tax on Foreign Property
Another common question during tax season surrounds avoiding capital gains tax on foreign property. Remember that the UK does not require the CGT if a property exists as an individual’s primary residence. Avoiding capital gains tax on foreign property is possible so long as the UK resident declares the international home as their primary residence.
The resident must declare to the government that the foreign home will serve as a primary residence. Typically, homeowners must make this declaration within two years of purchasing the foreign property. The only way this would become problematic is if the UK resident decided to sell both their foreign property and UK property in the same year.