Updated 4th August 2012
Reader's Question:
I purchased a flat 12 years ago to work in London. I have lived in the flat 5 days per week over that period while my wife remained in our other house in Glasgow to which I returned every weekend. I now wish to sell the flat. Am I liable for capital gains tax on the profit on the flat sale? How can I minimise CGT?
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My response:
Lovely question!
Private Residence Relief
Basically whether you pay tax on a property which you have lived in comes down to one key tax relief – called Private Residence Relief. This is a relief I've covered in a number of articles as it can save you a shed load of tax. So first of all read the following articles to get a broad understanding of how we can use Private Residence Relief to save tax:
Money tip #61 – Sell your second home tax free just like an MP
Money tip #106 – Getting married could land you with an unexpected tax bill
Reader’s Question: Avoiding tax on property sale
But to summarise for the benefit of other readers, ordinarily if you were to sell a property any profit which you make is liable to Capital Gains Tax (CGT - currently at a rate of 18% for basic rate income tax payers and 28% for higher rate income tax payers). However, you do not pay capital gains tax on the sale of your principal residence i.e. your main home – this is known as Private Residence Relief. If you did then every time you moved home you’d be landed with a huge tax bill.
Obviously, if you only own one house and live in it then this is your principal residence. But if someone has a second home or an investment property they can actually choose which is their principal residence and notify HMRC accordingly. You have to actually live in your nominated principal residence to qualify for Private Residence Relief otherwise the tax man will be after you. But if you nominate a second property as your principal residence just before you sell it, you avoid capital gains tax on the proportion of any gain assumed to relate to the period of time after you told the HM Revenue & Customs of the change in your main residence.
Your potential tax bill
I assume that your main home for tax purposes is the family home in Glasgow? For starters your principal residence will have to be the same as your wife's plus you don't mention ever having changed your nominated principal residence. It also doesn't seem like you've ever let your London crash pad out either. So to my mind that would suggest that the entire gain on the sale of the property will be liable to CGT. I'm guessing that you are a high-rate tax payer on the basis that you have two homes (I shouldn't assume really) which would mean that you would be taxed at 28%.
Exploiting the rules
Interestingly, a rule under Private Residence Relief often called the ‘’time to sell rule’’ allows a person to move out of their current home and into a newly purchased house without selling the previous one. As long as they sell the first house within 3 years of vacating it then the sale would be CGT free. In theory, you could change your principal residence to that of your London flat and then sell the flat which would mean the last 3 years worth of capital gain would be tax free. (i.e it would reduce the capital gain by a quarter as you would only pay tax on 9/12 worth of the gain). There isn't anything to stop you changing your nomination back again to your home in Scotland and still receive full tax relief on that property should you ever sell. For more details please read HMRC's guide to Private Residence Relief– which gives some neat examples.
But I would suggest that you seek tax advice before doing anything as you don't want to get it wrong or be have HMRC accuse you of fraud. Plus HMRC are not stupid and might see through what you are doing in any event – so beware.
Other ways to reduce your CGT bill
So what else can you do to reduce your CGT bill?
Use your CGT allowance – don't forget to deduct your annual capital gains tax allowance (currently £10,600) from your capital gain. If you've already used this year's annual allowance then you might think about waiting to sell until the new tax year which is just around the corner.
Joint ownership – it is possible to transfer ownership of assets between husband and wife (without incurring a CGT charge) in order to utilise both of your CGT allowances. This would be particularly useful if your wife is a basic rate tax payer (so part of her gain at least would be charged at only 18%). There are other tax consequences to bear in mind if your were to transfer ownership of your flat, assuming it's not jointly owned already. But once again – seek professional tax advice.
Offset the gain – if you have realised any capital losses in this tax year or indeed previous ones, these can be offset against the any gain and hence reduce your CGT bill.
Use of trusts – this is a complicated route but in theory you can split a property sale across tax years by gifting into trusts. Extremely complicated and only a solicitor/ tax specialist would be able to arrange this for you – which of course would cost money.
Deduct expenses – don't forget that when working out the chargeable gain you can deduct some of the costs of buying, selling and improving the property.
I hope that gives you some food for thought.
Good luck and tell your family and friends about me
Best Wishes
Damo
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