What is capital gains tax (CGT)?
One of the significant tax every property owners have to pay is the capital gains tax. Let's start with what is capital gains. In simple terms, capital gains mean the selling price less acquisition costs. For example, if you bought a property for £100,000 in 2001 and its market value now is £250,000, then you made capital gains of £150,000. If you sell this property for £250,000, then you have to pay capital gains tax on your gain of £150,000. The capital gains tax is a critical consideration for property investors because most property investments will be eventually sold and there will be a tax to pay on the gains.
There is an annual exemption for capital gains up to £12,300 which means no capital gains is payable on first £12,300. The annual exemption works similar as the personal allowance. To arrive at chargeable capital gains, we deduct annual exemption of £12,300 from the capital gains. For taxable gains, the CGT rates depend upon your taxable income. For the tax year 2021/22, the capital gains tax rate is as below:
Capital gains tax rates
There is an annual exemption for capital gains up to £11,700 which means no capital gains is payable on first £11,700. The annual exemption works similar as the personal allowance. To arrive at chargeable capital gains, we deduct annual exemption of £11,700 from the capital gains. For taxable gains, the CGT rates depend upon your taxable income. For the tax year 2018/19, the capital gains tax rate is as below:
Basic rate (threshold: £50,270 for 2021/22)
Higher rate (income more than basic rate limit)
You will notice that the capital gains tax rate is higher for gain on sale of residential property. This is one of the several measures the UK Government has taken to reduce participation of investors in the UK residential property market. As per HMRC, UK residential property includes the following:
Business Asset Disposal' Relief
If business asset disposal relief is applicable, the tax rates will be only 10% up to lifetime limit of £10 million. The bad news is that the business asset disposal relief does not apply to property investors in the majority of the cases. However, in the case of furnished holiday lets, property developers, property traders, property management business and other ordinary trading companies, the business asset disposal relief is available. Please contact us for any further advice on the availability of relief.
Who pays Capital gains tax?
Capital gains tax is payable by the following:
Companies usually pay corporation tax on capital gains.
How to calculate capital gains tax?
The calculation of capital gain is very straight forward. From the disposal proceeds, deduct the costs of acquisition to get the capital gain amount. Although the terms used here may seem jargons, the calculation is not that difficult for standard purchase/sale. Let's look at the example below:
Suppose Michael purchased a three bedroom house at the cost of £250,000 in 2006. He paid legal fees and stamp duty of £8,000 at the time of purchase. In 2011, he extended the house by adding one more bedroom and made some other capital improvement works with total costs of £50,000. His total costs to date are £308,000 (£250,000 purchase price plus £8,000 initial legal fees and £50,000 capital improvements).
He sold the house in 2021 for £650,000, and he paid estate agent and legal fees of £10,000 for sale. His net disposal proceeds will be £640,000 (£650,000 selling price less costs incurred for sale). His capital gains and tax payable will be calculated as shown below assuming Mr Michael is higher rate taxpayer:
Net disposal proceeds
Less: Acquisition costs & capital improvements
Less: Annual exemption
Taxable capital gains
Capital gains tax at 28% (assuming higher rate taxpayer)
When CGT arises?
The capital gains tax arises in the following situations: