Capital gains tax

In this article, we will explore all the basic things you need to know about capital gains tax on sale of property.

Big house and sun set - picture used to explain capital gains tax
  • What is capital gains tax?
  • Capital gains tax rates
  • Who pays capital gains tax?
  • How to calculate capital gains tax?
  • When CGT arises?
  • When is Capital gains tax due?

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.

UK Government collects more than £7 billion in revenue from capital gains tax every year! Although being such important source of revenue, its history is not that long. Capital Gains Tax (CGT) was first introduced by Harold Wilson's Government in 1965 on capital gains made on the disposal of assets by individuals, trusts and personal representatives of deceased persons. Lucky investors before then didn't have to pay any capital gains tax!

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:

Income Threshold

Residential property

 Others

Basic rate (threshold: £46,350 for 2018/19 and £50,000 for 2019/20)

18%

10%

Higher rate (income more than basic rate limit)

28%

20%

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:

  • an interest in UK residential property
  • properties in the process of being constructed or adapted for use as a dwelling
  • the right to acquire a UK residential property ‘off plan’
  • a UK residential property that isn’t your main home
  • your main home if its very large or you have let it out, used for business or has long period of absence

Entrepreneurs' Relief

If entrepreneurs' relief is applicable, the tax rates will be only 10% up to lifetime limit of £10 million. The bad news is that the entrepreneurs' 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 entrepreneurs' 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:

  • UK resident individuals and trusts
  • Non-UK resident persons selling UK residential property
  • Companies selling UK residential property worth more than £500,000

Companies usually pay corporation tax on capital gains. However, there is an exception for residential property worth more than £500,000. In this case, the company pay capital gains tax at the rate of 28% instead of corporation tax at the rate of 19%.

How to calculate capital gains tax?

The calculation of capital gain is very straight forward. From the disposal proceeds, deduct the costs of acquision 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 is £308,000 (£250,000 purchase price plus £8,000 initial legal fees and £50,000 capital improvements).

 

He sold the house in 2018 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 tax payer:


£

Net disposal proceeds

£640,000

Less: Acquisition costs & capital improvements

(£308,000)

Capital gains

£332,000

Less: Annual exemption

(£11,700)

Taxable capital gains

£320,300

Capital gains tax at 28% (assuming higher rate tax payer)

£89,684

When CGT arises?

The capital gains tax is arises in following situations:

  • Sale of property
  • Gift of property
  • Death of the owner
  • Loss or Destruction of asset
  • Transfer of property in any other means (e.g. transfer to Limited copmany on incorporation)

When is the capital gains tax due?

The tax is due on 31 January following the tax year in which gain is made. For example, if the property was sold on August 2018, this falls within tax year 2018/19 and so the tax is due on 31 January 2020.