How to Avoid Capital Gains Tax on Second Homes in the UK

Selling a property in the UK brings with it financial considerations, including CGT (Capital Gains Tax). It is a tax on any gain you make from selling assets, which includes second homes. Fortunately, various strategies and exemptions can help individuals decide at what point you pay capital gains tax on second homes.

In this article, we will aim to explore what is Capital Gains Tax in the UK as well as various methods to mitigate CGT liabilities and understand the relevant regulations in the UK.

What Is Capital Gains Tax in the UK?

In the UK, CGT is a levy imposed on the capital gain you make when selling, transferring, or disposing of an asset that has grown in worth. Capital Gains Tax applies to various assets, from properties that do not include your main home to stocks and shares, business assets, and valuable personal possessions.

Here are some key points about capital gains tax in the UK:

• Taxable Gain: Taxable gain can be determined by deducting the cost of obtaining an asset, including any related expenses, from the profit you make selling it.

• Annual Exempt Amount: The Annual Exempt Amount, which is how much you can earn tax-free every year for the 2022/2023 tax year, stands at £12,300. If your cumulative capital gains don’t cross this limit in a single financial year, you will not have to worry about paying any capital gains tax.

• Rates: From the 2022/2023 tax year, the capital gains tax rate majorly depends on your income bracket. These are the current applicable rates:

1. Basic Rate Taxpayers: The net profits would be taxed at 10% after considering any applicable deductions or exemptions. 
2. Higher and Additional Rate Taxpayers: Gains are subject to a 20% tax rate (minus any deductions or exemptions apply).

• Special Rates for Residential Property: For residential property transactions after April 2022, different tax rates will apply to capital gains generated. These new rates will take effect in the 2022/2023 tax year.

1. Basic Rate Taxpayers: 18% on residential property gains.
2. Higher and Additional Rate Taxpayers: 28% on residential property gains.

• Allowable Deductions: When calculating the taxable gain from an asset, certain associated costs and expenses can be deducted. These could include costs for acquiring, enhancing, or selling the asset.

• Capital Gains Tax Allowances and Reliefs: People can be exempt from paying capital gains tax in some cases due to a range of allowances and reliefs. These include Entrepreneurs Relief, Investors’ Relief, and various other kinds of relief for different kinds of business assets.

• Reporting and Payment: If you gained more money than the annual exemption limit, you must report it on a self-assessment tax return. The tax should be paid before 31st January of the following year after making those gains.

At What Point Do You Pay Capital Gains Tax?

In the UK, capital gains tax (CGT) is payable when you generate a benefit or gain from selling particular assets.

Here are the key points that determine when you need to pay CGT:

• Taxable Events: Capital gains tax is activated when an asset has grown in value and is disposed of. This includes selling property (not including the primary residence), gifting assets, transferring ownership of assets, or receiving payment for an asset.

• Exceeding the Annual Exempt Amount: Every person is granted an Annual Exempt Amount Capital gains tax of £12,300 for the 2022/2023 tax year that is exempt from capital gains tax on disposals. Should your total gains surpass this figure, you must pay a capital gain tax on the amount above the threshold.

• Reporting and Payment: Reporting and paying taxes is important if you’ve made more money from capital gains than the Annual Exempt Amount of Capital gains tax. Generally, this is done by submitting a self-assessment tax return. Taxpayers must file their returns and make the payment by the 31st of January of the year following the one in which the gains were made. This is when the deadline comes into effect.

It’s vital to know that certain assets, like primary residences, may have unique rules and tax treatments. Hence, it is important to research them thoroughly before finalizing any decisions. Furthermore, the taxation of profits from a residential property sale may vary based on an individual’s tax rate. Also, different tax brackets could affect the rate of gain for such investments.

Principal Private Residence Relief (PPR)

PPR Relief is a major tax concession that can be applied to second properties, giving homeowners a notable exemption on the costs associated with them. Principal Private Residence (PPR) allows you to be free from capital gains tax when you sell a property that has been your primary residence at some point during its ownership. However, in order to qualify for PPR, certain eligibility criteria need to be fulfilled.

• Occupancy as a main residence: The house must have been the owner’s primary residence at some point throughout their ownership. This applies to both before and after the property was let out or vacant.

• Period of ownership: PPR relief can be claimed regardless of property ownership tenure. However, the property has not been used as a main residence throughout its ownership period. In that case, the amount of relief claimed may be reduced depending on how long it wasn’t occupied.

• Size of the property: Permitted Development Rights (PPR) are usually applicable to main dwellings and gardens covering an area of 0.5 hectares or less. However, if a bigger property is required for the appropriate use of the dwelling, then PDRs may still be granted.

• Absence relief: It’s possible to receive PPR even if the property wasn’t your main residence for the entire period of ownership. This can be applicable in certain situations, such as a job relocation up to 4 years or absences of any duration due to disability.

By meeting Principal Private Residence Relief criteria, individuals can significantly reduce or eliminate their capital gains tax liability when selling a second home.

Other Strategies to Minimize Capital Gains Tax

1. Utilizing the annual exempt amount: It’s possible to avoid capital gains tax by utilizing the annual exempt amount capital gains tax. Strategic timing can ensure that the total gains generated are within the exempt threshold when selling assets such as second homes.
2. Spousal transfers: Married couples and civil partners can shift assets between one another without triggering capital gains tax. By changing the ownership of a second home to a spouse or partner with a lower tax rate, you could effectively decrease or eliminate your overall tax liability.
3. Lettings Relief: Lettings Relief provides a potential extra allowance of up to £40,000 per owner in addition to Principal Private Residence Relief. It is available when a property was previously occupied as residential housing and the landlord wants to claim relief.
4. Incorporation: If you have many pieces of property, setting up a limited company structure may help reduce your capital gains tax. This could be beneficial for those looking to manage their investments more efficiently. Nonetheless, this approach may have unintended tax implications and should be taken cautiously. It is highly advised to seek professional counsel prior to embracing this option.
5. Gift holdover relief: One way to avoid the capital gains tax imposed on second homes is through gift postpone relief. Essentially, this allows homeowners to transfer ownership of their house or apartment to a loved one or a trust without being immediately liable for that tax. Regarding capital gains tax calculations, the recipient of the property assumes its original acquisition cost.
6. Use multiple owners: When two individuals jointly own a second home, they are entitled to their annual exemption limit, which effectively doubles the tax exemption amount. To help you get the best tax benefit, it makes sense to distribute ownership of your assets among multiple individuals. This can help you use your annual exempt amount and lower capital gains tax payments.
7. Carry forward losses: Capital gains tax regulations permit individuals to use losses from previous years against their current gains. That means if you have any loss from other investments, you can utilize it to reduce the taxes on selling a second home. Utilizing losses is a great way to minimize capital gains tax liability.

Conclusion

Property owners in the UK are frequently overburdened by complications with capital gains tax that pertain to their second homes. Nonetheless, being aware of pertinent regulations and taking advantage of available exemptions can help them successfully reduce or nullify CGT liabilities. Principal Private Residence Relief is an invaluable relief that can spare individuals from incurring capital gain tax if the property has been their principal residence for any time.

Tax burden can be reduced by using yearly exempt amounts, spousal transfers, lettings relief, incorporation, gift holdover reliefs, a few proprietors, and carrying forward losses. These strategies should not be overlooked. Whenever you are looking to sell a second home, it is highly recommended that you get professional advice to adhere to the regulations set by tax laws and maximize your tax savings. 

FAQs

1. Can I avoid paying CGT on my second home if I have never lived in it as my main residence?

Sadly, you won’t be able to take advantage of Principal Private Residence Relief (PPR) if the property has never been your primary home. However, other options can help you limit the amount of capital gains tax you must pay, such as the annual exempt amount and lettings relief.

2. Is there a minimum period of ownership required to qualify for Principal Private Residence Relief?

You don’t have to own a property for a certain time to qualify for Principal Private Residence Relief. Even if you’ve only lived in the property for a short while, you may still be eligible for this relief, provided that it was your main residence at some point during your ownership. If your property was not used as a primary residence for the entire time of ownership, the relief could be reduced accordingly.

3. Can I transfer ownership of my second home to my spouse to avoid CGT?

You can transfer ownership of a second home to your spouse and civil partner without paying capital gains tax. This can be beneficial in the long run as it would allow both partners to use their annual tax exemption and possibly reduce their overall tax burden.

4. Are there any time limits for claiming lettings relief on a second home?

Claiming lettings relief comes with certain restrictions from April 6, 2020. It applies only if you lived in the property during the letting period and have an individual cap of £40,000 per owner. Staying on top of the essential occupancy and rent periods is pivotal to guaranteeing you are eligible for this relief.