How To Avoid Capital Gains Tax On A Second Home

April Calendar

If you’re in the process of selling your second home or you’re about to be in that process, it’s easy to think about what you’ll make of the process. Selling that second home could mean moving up into your own dream home or funding your retirement. The biggest possible profit is, obviously, your key goal, but have you considered the biggest potential impact on your earnings – capital gains tax?

What Is Capital Gains Tax In The UK?

When any home increases in value, it’s a bit of a double-edged sword. The positive outcome is that you can leverage your home and take advantage of the amazing investment you’ve built. The drawback, however, is that the substantial increase in value means quite a sum when tax time comes. This is particularly true with a second home because the government classifies it as an investment property, so you’ll almost certainly be responsible for capital gains tax on it.

Capital gains tax, sometimes called the second home tax, is one that you pay when you sell any asset that has increased in value over the time you’ve owned it. (You may see this tax abbreviated as CGT on property.) In other words, you will owe a tax for a second home on the profit you’ve made on that investment. To learn exactly how much you’ve made off of that investment, you’ll just subtract the original purchase price of the investment from the final sales price. Imagine, for example, you bought your second home for £200,000. Now the home is worth £350,000. You’ve made a profit of £150,000. You don’t owe all of that profit in capital gains taxes. Instead, you owe a percentage of that £150,000 in capital gains taxes. How much is capital gains tax on property? Basic rate taxpayers pay a rate of 18%. Higher rate taxpayers pay a rate of 28%. In other words, if you’re a basic rate taxpayer, you would pay £27,000 on the sale of that second home.

You can typically calculate what you might owe for the tax on the sale of the property. There are many capital gains tax calculator UK options available online to help you better understand what the costs will be after you sell your home.

It’s important to note that capital gains on second-home properties are the only kinds of capital gains taxes that exist. They must be paid on personal possessions that are worth more than £6,000 including jewellery and antiques. They may also be paid on your primary home if you let it out for business purposes. Additionally, they could be paid on business assets or any shares that are not part of a Personal Equity Plan.

HM Revenue & Customs relies on capital gains taxes for quite a bit of revenue. In 2022, they collected £14.9 billion in capital gains taxes alone.

Understanding The 36-Month Rule

The 36-month rule for capital gains tax in the UK is the idea that there is an exemption period before the sale of the property. This was 36 months at one time, but these days, it’s a bit less. Tax is paid on the chargeable gain you made from the sale of your property. You are charged this gain minus the private residence relief if you are entitled to it. These days, you get relief for the last 9 months you owned the property. If you own just one home, though, full relief can be applied for the last 36 months.

How To Avoid Capital Gains Tax On Second Homes In The UK

If you want to sell your second home – whether you’re using it as a vacation property or a buy-to-let property, it can be tough to avoid this second property tax on those properties because the rules that surround them are quite different from the rules that surround selling your primary residence. You have to pay that tax when you sell the property, if you inherit that property, or if that property has increased in value.

The tax on selling a second home itself is based on the profit you make from the home and your tax band, but it may be possible to reduce those taxes.

One way you can reduce the tax on second homes you need to pay is to make certain you take your annual capital gains tax allowance. All UK residents can take advantage of an annual allowance of £12,300. If the value of that second home hasn’t grown that much, and the profit you make is less than that, you won’t have to pay this second home’s tax. If you own the property with another person – like your spouse – the two of you can combine your allowance to ensure that you don’t have to pay taxes on £24,600 of what you make off of the property.

Keep in mind that the allowance isn’t the only way to reduce your capital gains taxes on a second property. Other factors can be deducted from your profits to help reduce your overall liability here. You can deduct the Stamp Duty you had to pay on the property, any estate agent fees that are required within marketing the property, the solicitor fees that are required to ensure the transfer of the property from one person to the next, and the other fees like valuation fees, and repair fees to ensure it’s ready to sell. Imagine, for example, if all of those fees added up to £30,000. You wouldn’t be responsible for any of that £30,000, and thus you wouldn’t be taxed on as much of the profits as you initially imagined.

Another option you have to reduce the capital gains tax on second homes is by declaring your second home as your primary residence. The UK allows you to decide which property is your main home, and you can change that within two years of owning the second residence. That right to choose is limited to those two years, and whilst you don’t have to spend the majority of your time there, you do have to nominate it as your main residence legally. Here’s a quick example of how it works. Imagine you have a cottage that is your only property. You decide to buy a new flat in the city. You have two years from the day you buy that new flat in the city to declare which is your main residence. Two years later, you buy a third house. You now have two more years to decide which is your main residence. If the cottage is declared as your main residence at that point, and you decide to sell it, you no longer have to pay capital gains taxes on that property. In this way, you may not have to pay capital gains tax on a property you previously lived in, even if you don’t live there full time now.

The last way to ensure you reduce your overall tax on selling property is to sell an inherited property as soon as possible. Remember that an inherited property counts in terms of this 2nd home tax, and while it may seem like that’s a real plus for your financially, you still have to pay capital gains taxes on it when you inherit it. If you sell it as soon as possible, you’ll reduce your burden because those taxes are based on the increase in value from the time you acquire the home until the time you sell it. If you can sell the home fast enough, you may not owe a significant amount of capital gains taxes on it.

If you are flipping houses, avoid capital gains tax in the UK by consulting with a financial advisor before you decide to finish the flip. They may have some ideas about how to better reduce your overall tax burden so you won’t have to pay as much capital gains tax on the second home.

What If You Sell To A Cash Buyer?

Many who own a second home today are looking to sell quite quickly, and that can typically be accomplished by working with a cash buyer. It’s important to note that whether you’re working with a buyer who must obtain a mortgage on the property, a buyer who is paying cash, or a cash investor, you must still pay capital gains tax on a second home. If you cannot meet all of the criteria for private residence relief which include – the residence is declared as your main home, you do not let out a portion of that home, you have not used that home for business purposes, you didn’t purchase the home solely making a profit, the property as a whole is less than an acre in size – you will have to pay capital gains taxes on it no matter who the buyer may be.

Keep in mind, though, that cash buyers tend to pay less than fair market value, and that may work in your favour if you’re trying to reduce the amount of tax on a second home you may owe. There’s a very good chance that because you’re only likely getting about 80% of the fair market value of the home with a cash buyer, you may be able to reduce the tax on selling a house that you owe. If, on the other hand, a cash buyer pays quite a bit more than the market value of the property, you may still owe the full amount of capital gains taxes. The calculation is wholly dependent on how much money you earn on the property after you deduct the expenses involved with actually selling it.

If The Property Isn’t Located In The UK

If you own a property in a foreign country, selling it can be a bit more complicated. In short, you will still owe capital gains taxes in the UK. Keep in mind that these apply to any asset you hold in any country in which you make a real profit. You may also owe capital gains taxes on that property in the country where you sold it, though, so you’ll need to work with your solicitor and a financial advisor to better understand exactly how that might work in both locations. Often nominating that property as your main residence within the allowable time frame can help you reduce what you may end up owing.

Paying The Capital Gains Taxes

Often no amount of planning will reduce your tax burden entirely, and in those situations, you will have to pay some capital gains taxes. You have to report all taxable income and gains that fall within any given tax year, and if you’ve explored all of your options and determined what you owe, you’ll need to report that to HM Revenue & Customs. Keep in mind that you won’t get a bill from them. Instead, you’ll need to work out on your own what you owe and decide whether you’re above the tax-free allowance.

You typically have 60 days to report and pay capital gains taxes on the sale of the property. This is a bit different from other taxes that you wait until the next tax year to pay. In this situation, you pay them within two months, so you must pay attention to those limits, as there are financial penalties that come along with them if you aren’t paying attention.

When you do report those gains, you’ll need quite a bit of information at the ready. You’ll need the details of the property sale itself. Be sure you have the amount you initially paid for the property and the amount for which the property sold at your fingertips.

You’ll also need the date you took ownership of the property as well as the date you sold the property.

If there are relevant expenses that came with selling the property, you’ll want to list those as well. Those relevant expenses can (and should) include things like the cost of the estate agent, the cost of the solicitor, any repairs or modifications you needed to make to the property to make it more attractive to buyers, and other involved fees like a survey fee and more.

You should also list any relevant details of the relief you are entitled to. For example, if you are taking a personal exemption of the maximum amount and your spouse is too, you’ll need to list all of those.

Fortunately, this process shouldn’t be too complex. You can easily have a financial advisor or a solicitor handle all of the calculations for you and even handle paying the tax for you if that is required.

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