By taking advantage of private residence relief and some of its features, it is possible to capitalise on lifestyle events and to grow a £million pound property portfolio free of capital gains tax (CGT).
Private residence relief at a glance
Private residence relief removes the charge to CGT that would otherwise arise on a gain made on the disposal of the owner’s only or main residence. Where the owner has more than one property, the owner can elect which is to be the main residence.
If a property has not been the main residence throughout the period of ownership, it may be that not all the gain will be tax-free as it is necessary to apportion the gain between the period of time when the property was the main residence and when it was not. However, there is a general rule that the last 36 months of ownership are exempt from tax and this may rule may shelter any chargeable gain that would otherwise arise.
An element of relief is also available for properties which have been the main residence at some point and which have also been let out.
In growing your CGT-free property value, the annual exemption should not be overlooked. A CGT liability only arises if gains exceed the annual exemption, set at £10,600 for 2012/13. This means that where a property is jointly-owned, CGT will only be payable if the gain exceeds £21,200 (2012/13 figures). Costs of acquisition and disposal are deducted in computing the gain.
Case study – growing your CGT portfolio
After graduating from University and starting work, Becky buys her first property in 1993. The property is a one-bedroom flat which costs £60,000. She lives in the property for two years. In December 1995, she moves into her boyfriend Adam’s house and lets out her flat. They marry in 1996 and decide to move to a bigger property.
They are both doing well at work and have enjoyed promotions and pay rises. They sell Becky’s flat for £155,000 in September 1996. Although there is a gain on the sale, the gain is free of CGT. The property was Becky’s main residence until December 1995 and private residence relief applies. The last 36 months of ownership are free of tax, taking the whole gain out of charge.
Becky and Adam buy a three-bedroom semi-detached house on 1 January 1997 for £180,000 and move in. They keep Adam’s previous two-bedroom house and let it out. Following the birth of their daughter Rosie in 2002, they decide to move to a larger house. To finance the move, they sell the two-bedroom property, realising a chargeable gain (after deducting the costs of sale and purchase) of £100,000.
The property was purchased by Adam on 1 September 1992 and sold on 31 August 2002, realising a gain of £100,000. It was owned by Adam for 10 years (120 months). The property was Adam’s principal private residence until 1 January 1997 – a period of 52 months. As the property has been Adam’s principal private residence at some point, the last 36 months’ ownership are also free of CGT. Consequently, private residence relief covers 88/120th of the gain, i.e. £73,333 (88/120 x £100,000).
As the property has been let, lettings relief is in point. Letting relief is available to a maximum of the lower of:
•the gain attributable to the property while let -- £56,666 (68/120 x £100,000)
•the amount of private residence relief due -- £73,333.
Therefore letting relief of £40,000is also available.
The gain of £100,000 is completely tax-free -- £
73,333 is covered by private residence relief and balance by lettings relief.
Becky and Adam move into their new home on 1 September 2002 – a four-bedroom property costing £400,000. Their second daughter Alice is born in July 2004. Keen to move up the property ladder, they sell the three-bedroom property in July 2005, realising a gain of £170,000. Once again the gain is completely free of CGT. The family lived in the property as their main residence until 1 September 2002 and the last 36 months of ownership are tax –free.
Becky and Adam purchase a five bedroom house for £600,000 on 1 December 2005. Once again they let out their previous home when they move. Their son Harry is born in September 2006. Adam continues to enjoy career success and they inherit some money from Becky’s grandmother following her death in June 2008.
They sell the four-bedroom house in November 2008, realising a gain of £200,000. The gain is once again tax-free. They lived in the property as their main residence from 1 September 2002 until 30 September 2005 and sold it just under three years later to take advantage of the fact that the last 36 months of ownership are free of CGT.
They find their dream home in December 2009, which they purchase for £950,000. They move out of the five bedroom house which once again they let out. In November 2012, they own property worth over £1.5 million and have grown their property portfolio without paying any CGT.
This case study illustrates how it is possible to move up the property ladder, keep an investment property and realise gains without paying any CGT by taking advantage of the fact that once a property has been used as a main residence for capital gains tax purposes, the last 36 months of ownership are covered by main residence relief and are free of CGT.
However, there are some words of caution. Moving house is an expensive business and stamp duty land tax (SDLT) increases as the price of the property increases. At current rates, SDLT is 1% on properties between £125,001 and £250,000; 3% on properties between £250,001 and £500,000, 4% on properties costing between £500,001 and £1 million and 5% on properties costing over £1 million. This means that the SDLT hit on a property costing £600,000 is £24,000. Consequently, in a stagnant market or one in which house prices are only rising slowly, it may not be worthwhile making frequent moves to shelter any gain that may arise as the CGT savings may be outweighed by SDLT and other costs associated with moving.
As always, it is necessary to look at the overall picture and evaluate the tax saving opportunities afforded by private residence relief against the wider considerations to make a considered decision for the given circumstances.
Practical Tip :
It is possible to build up a significant property portfolio by moving house every three years or so and letting out the previous house to make maximum use of private residence relief. However, as always, care should be taken not to let the tax tail wag the dog and all relevant factors, including the costs of moving and the associated SDLT implications should be taken into consideration.