How To Avoid Capital Gains Tax On Real Estate?

When you are selling your home, or you plan to do so shortly, it is easy to think about the proceeds. After all, you need to sell up to move to your dream home or a smaller abode, fund your retirement, pay for care or otherwise transition to a new chapter. You are making a profit (and as much of one as possible!) is a crucial goal for the vast majority of sellers. But a big factor could impact the earnings you realise on a sale: the capital gains tax.

When your home increases in value, it can be a double-edged sword. On the plus side, you can leverage your home to secure a more favourable mortgage or secure other forms of lending. On the downside, with a substantial increase in value, you may be responsible for a large sum when it comes time to do your annual income tax.

The good news is that there are ways to avoid capital gain tax. In this guide, we will cover important topics, including:

• What Is the Capital Gains Tax?
• Do You Have to Pay Capital Gains Tax When You Sell Your Home?
• How Much Is the Capital Gains Tax?
• Avoiding Capital Gains Tax
• Reducing Your Capital Gains Tax Burden
• Paying Capital Gains Tax

Let’s get started.

What Is the Capital Gains Tax?

Capital gains is a tax you pay when you “dispose of” or sell an asset that has increased in value during the time in which you owed it. In other words, you owe a tax on the profit (that is, the capital gain) you have made. Generally, you start with the final sale price and subtract the original cost or purchase price and any expenses incurred. Let’s look at an example so it becomes more clear. Say, for example, you purchased a home for £200,000. You spent £50,000 on upgrades and improvements during the time you owned it. When you sold, the final purchase price was £350,000. So:

£350,000 – £200,000 – £50,000 = £100,000.

Fortunately, this does not mean you owe a £100,000 tax! Rather, you owe taxes on £100,000 of income. How much? It depends on your income and whether the house you have sold was your primary residence or additional home (e.g. holiday home) or rental property.

You also pay capital gains tax on other assets that you sell. These “chargeable assets” include:

• Most personal possessions are worth £6000 or more. These items can include jewellery, antiques, paintings, coins and sets, sets or collections (e.g. matching vases). You do not have to pay capital gains tax on your vehicle.
• Property excluding your main home.
• Your primary or main home if you let it out or use it for business purposes.
• Your primary or main home if it is very large.
• Business assets.
• Shares that are not in a Personal Equity Plan (PEP) or an Individual Savings Account (ISA).

In the 2021 – 2022 tax year, HM Revenue & Custom collected over £14.9 billion in capital gains tax. This was a record year and an increase of £3.7 billion over the previous tax year.

Do You Have to Pay Capital Gains Tax When You Sell Your House?

In many cases, the answer is “No.” Surprised? Well, at least it’s a good surprise! If ALL of the following criteria are true for you, then you do not have to pay capital gains tax.

• You own a single home and you have used it as your primary residence for the time you owned it. One of the best ways to avoid capital gains tax is family living in the home!
• You have not let out a portion of your home, though having a lodge is acceptable.
• You have not used part of your home exclusively for business purposes. If you use a room as a temporary office or an occasional workspace, it does not qualify as exclusive business use.
• You did not purchase the house just to make a profit or gain.
• The property, including all buildings, is less than 5000 square metres, which is just over an acre.

If all of these conditions are true for your situation, you automatically receive Private Residence Relief, freeing you from having to pay capital gains tax. If any of them, even one, apply to you, it is most likely that you will be liable for at least some payment. You can figure out if you qualify for tax relief when you sell your home here.

How Much Is Capital Gains Tax?

If you are not eligible for Private Residence Relief, the capital gains tax rate you will be charged is 18% for standard rate taxpayers and 28% for higher rate taxpayers. You will pay tax on the profit, or gain, from the property less the capital gain tax allowance. But it can get tricky here. Capital gains tax (CGT) is charged at 18% on the amount that the seller has available in the basic rate band. If the property value increases significantly (as we have seen recently across the UK), the basic rate band is frequently used up. Thus, most of the gain is taxed at 28%, even if the taxpayer pays the basic rate for their income tax.

In other words, the CGT rate you pay is dependent upon the size of your gain and other taxable income. That you are a basic rate taxpayer is not the deciding factor here.

We mentioned the term, capital gain tax allowance. What is this? As a taxpayer, you have an annual CGT allowance. This means that you can earn a certain amount that is tax-free. Currently, this figure is £12,300. If you own the house or property jointly with a spouse, you may combine both of your CGT allowances.

Going back to the big issue: How much is capital gains tax? As mentioned, it is a basic formula that subtracts the price for which you purchased the property and expenses from the sale price. You are allowed to deduct costs associated with selling, including estate agent fees, legal fees, improvement costs, etc. You may not deduct maintenance costs.

If this equation equals less than your CGT allowance, you do not have to pay capital gains. If it is more than your CGT allowance, you will be taxed on the overage.

Avoiding Capital Gains Tax

As mentioned, there are several conditions that, if you meet them, you do not have to pay CGT. A simple one: you can avoid capital gains tax by living on the property for at least two years. When it is your main home, you typically do not have to pay this tax (unless, as discussed, it is exceptionally large or you are a high-income earner). You can avoid capital gain tax in buy-to-let situations in the same way.

Let’s look at some other scenarios:

Avoid capital gains tax on inherited property

Some people assume that they can escape paying capital gains tax if they gift their home to their children. Unfortunately, this is not the case. You will have to pay CGT just as if you had sold it. Instead of the sale price, you will use the home’s market value to determine how much you will be charged. As before, you also deduct expenses.

If you inherit property but do not live in it, you will have to pay capital gains tax if you sell. This will be calculated based on the difference in value from when you acquired the property to when you sell, once again deducting any selling expenses.

There is a workaround here if your property is worth less than £650,000 and it is fully paid off. In this case, you can leave the house to your child through a trust. Let’s put some numbers into this story. Say you bought your house for £100,000 and it is worth £200,000 now. You gift it to your child through a trust. You can then agree to a TCGA Section 260. This allows you to use your lifetime Inheritance Tax-free allowance in place of paying capital gains tax.

Another benefit of this is that you can avoid inheritance tax too, which is charged at a very high 40%. Every UK taxpayer has a lifetime inheritance tax-free allowance amounting to £325,000.

You can also gift your house to a spouse, civil partner or charity to eliminate the need to pay capital gains tax. It is important to speak to an estate planning expert as you may be able to use your will to avoid capital gains tax.

Avoid capital gains tax by remortgaging

Refinancing could be an easy way to bypass capital gains tax. When you remortgage, you do so based on its current value. For example, if you purchased your house for £80 but it is now worth £160, you can refinance for that amount. Your new house repayment is a 25% loan-to-value, and you can leverage all £120,000. Remember, capital gains are based on the difference between the sales price and the original purchase price – on the gain you made. In this case, you have not made a “gain” per se, at least not in terms of CGT.

Avoid capital gains tax by reinvesting in two properties

While you may not be able to avoid this tax altogether, you can likely defer capital gains tax if you sell one property and reinvest in others. Be sure to consult a tax specialist as there is a myriad of nuances of which you need to be aware.

Reduce capital gains tax by nominating your primary home strategically

If you have more than one property, you are not eligible for Private Residence Relief. But you can nominate which property you would like to be tax-free when it comes to selling. It doesn’t necessarily have to be the one in which you spend most of your time either. It is advantageous to nominate the home that will have the largest gain upon sale. You can nominate a home as your main residence within two years of when you acquire it.

Establish Trusts to Avoid CGT

If you want to avoid capital gains tax, death isn’t even enough in some cases! You do not have to pay CGT on property that was not sold before the person passed away. If the property is sold during probate and if its value has increased since the owner’s death, there will be a tax. If the value has not increased or is within the capital gains allowance, then you will not if you sell the property. As discussed earlier, people can do some estate planning to help avoid CTG and even inheritance tax and stamp duty. Trust may be an effective solution. Make sure to discuss this with a qualified financial planner and/or estate planner.

Avoid Capital Gains by Gifting Your House to Your Spouse or Civil Partner

Thankfully, property transfers between spouses or civil partners are all but exempt from capital gains tax. You can use both of your annual CGT allowances, a total of £24,600. To qualify, the transfer must be an “unpretentious and absolute gift.”

Avoid Capital Gains Taxes on Second Homes

If you want to sell your second home or a buy-to-let property, you will likely face capital gains taxes on the proceeds you earn. The rules around CGT for second properties are different to those for main residences, as we have discussed. You must pay tax when you sell if you inherited the property and it has increased in value and if you transfer a portion of the property to another party.

As with capital gain tax on a primary home, you will be based on the profit you made from the sale of your second home or buy-to-let, your tax band and any improvements you have made to the property. Basic rate taxpayers are charged at 18% while higher rate taxpayers are charged at 28%.

Even with a second home, you may be able to avoid or reduce capital gains tax.

• Annual capital gains tax allowance. As discussed, UK residents can take advantage of an allowance of £12,300. So, if your home’s value has not grown by more than that sum or the profit you realise is less, you do not pay CGT. If you own a property with your spouse, you can combine your CGT allowance for a total of £24,600.
• Consider other factors that can be deducted from your profits in calculating capital gains tax. These include stamp duty, estate agent fees, solicitor fees, costs for valuations and surveying, and improvement costs (e.g. extensions, replacing electrical/heating symptoms, etc.). For example, if you spent £30,000 on all of these items, you can add your annual allowance for a significant reduction in your taxable profits. You do not have to pay CGT if these deductions and your allowance are large enough.
• Change your place of residence. In the UK, you can nominate which of your properties you claim as your main home. Why? Most often, you do not have to pay capital gains tax on your primary residence. In this way, you can qualify for Private Residence Relief. You’ll still have the second property, but you can claim the property that will generate the most profit as the primary residence to reduce your tax.
• Sell an inherited property right away. An inherited property can be a boon – but it can also be a financial bust. You are the one who will have to pay capital gains tax if you want to sell it. If this is the case, sell it as soon as possible. CGT is calculated based on the increase in value from when you acquired the home to when you sell it. If you can sell it fast enough, you can get that tax down to a level where it should be covered by your CGT allowance and deductions.

If you have inherited property, selling it fast may be in your best interests. Consult with a financial advisor. If you do decide to go forward with a sale, remember that time is of the essence. You may not want to risk waiting for months (or longer in a cool market) to find the right buyer, especially if Grandmom or Aunt Lucielle did not leave you a house in great condition.

Working with a cash house buyer can accelerate the process significantly. You can often complete a sale within just 7 days – which gives the home no time to increase in value. Another benefit is that cash buyers purchase properties in as-is condition. You do not have to spend untold time and money making repairs and updates that typical buyers would demand. Nor do you have to pay for estate agent fees, solicitors, valuations experts, surveyors, etc. All of these expenses are taken on by the buyer. What do you do?

You accept or decline the first offer in principle. You wait (just a few days!) for the buyer instructions survey. You accept or decline the formal offer. You pack up, arrange removals and then confirm that cash has been deposited into your account as the sale completes. That’s it. It is perhaps the easiest way to sell a house and unburden yourself from an inherited property that does not suit your needs.

Reduce Capital Gains Tax with Savvy Investing

You can do this in a few different ways. For example, you can invest in an ISA. You can contribute up to £20,000 a year (£40,000 for spouses and civil partners). Likewise, you can contribute to a pension. Doing so will increase the upper limit of your tax band. Let’s say that you contributed £10,000. Here, the point at which a higher rate of tax becomes payable rises from £50,270 to £60,270. If your taxable income and capital gain land within this band, capital gains tax is payable at 10% rather than the 20% you would have paid before.

Deduct Expenses to Reduce Capital Gains Tax

If you do have some capital gains to pay, lower the amount of the profit that is taxable. Deduct everything allowable. This includes:

• The costs associated with repairs to a home and property
• Improvements and upgrades to the property, such as extensions, renovations and the like.
• Losses you realised from investment property (i.e. tenants were not able to pay rent).
• Completion costs
• Estate agent costs
• Legal costs

Keep all of your receipts, invoices, bills, statements and other supporting documentation.

Avoiding Capital Gains Tax When Selling a Foreign Property

If you own property in another country, selling can be complicated. You will have to pay capital gains tax in the UK, and you may have to pay capital gains tax in the country in which your property is located. Being taxed twice is certainly not a palatable thought for many! Here again, you can bypass the need to pay CGT if you nominate your foreign property as your primary residence. Remember, you do not have to pay this tax on your main home. Usually, you must declare to the UK government that your foreign property is your primary residence within two years of purchase.

Now, it can become complicated if you wish to sell a UK property and a foreign property in the same year. You will have to pay capital gains tax on one of the properties. While there are ways to avoid this, it is best to consider nominating the property that will yield the highest profit as your primary residence.

Please consult gov.co.uk for more information on this issue for UK residents who are domiciled abroad.

Paying Capital Gains Tax

In some cases, no amount of financial planning and strategy is sufficient, and there will be some capital gains tax to be paid. No, you can’t avoid capital gains tax with offshore accounts or by hiding assets. You must report all taxable income and all gains that fall within the specified parameters.

If you’ve explored all your options and determined you owe capital gains tax, you are required to report and pay CGT to HM Revenue & Customs. You won’t receive a bill; rather you must work it out on your own to determine if your gains are above the tax-free allowance.

If you sold a property in the UK on or before October 21, 2021, you have to report and pay capital gains tax within 60 days. You do not wait until the next tax year.

If you are not a UK resident, you are required to report all sales of a property or land in the UK, even if no tax is owed.

When you report gains, you need to have ready:

• Details as to the amount you bought and sold the property for
• The date you took ownership of the property and the date you sold it
• Relevant details, such as the expenses associated with buying, selling or making improvements
• Relevant details as to the relief to which you are entitled

You can find more information on working out your capital gains tax, reporting and paying HMRC at gov.co.uk.

Explore Your Options

Let’s face it: no one wants to pay more taxes than they feel they should! Selling a house is complicated and stressful enough as it is. The last thing you want is to pay taxes that eat away at your profits – which could make it much more challenging to make your next move.

The good news is that many people who sell do not have to pay capital gains because they qualify for Private Residence Relief. The issue becomes much more complicated when you add in second homes, investment properties, trusts and the like. The best course of action is to see if you would have to pay capital gains taxes and speak with a financial expert to determine the most logical ways to either avoid or reduce CGT as much as possible.

Will, I Have to Pay Capital Gains If I Sell My House Fast?

It depends. As mentioned previously, many people in the UK do not have to pay capital gains when they sell their homes. See if you tick all the boxes we mentioned above. To recap, to qualify for Private Residence Relief, you must meet all of these criteria:

• You own one home and you have used it as your main home for the entire time you owned it.
• You have not let out a portion of your home, though having a lodge is acceptable.
• You have not used part of your home exclusively for business purposes. If you use a room as a temporary office or an occasional workspace, it does not qualify as exclusive business use.
• You did not purchase the house just to make a profit or gain.
• The property, including all buildings, is less than 5000 square metres, which is just over an acre.

Likely you will not have to pay capital gains tax at all. Another point in your favour here is that cash buyers typically offer between 80 and 85% of the total market value. This ends up being advantageous for many because the costs of selling a house are borne by the buyer. But in the capital gains tax calculation, you will often have a slightly lower sales price to use in your calculations.

In this guide, we have covered a lot of ground related to capital gains taxes. This is a major source of revenue for HMRC, amounting to billions of pounds. While taxes are an important component in funding public programs, infrastructure and the like, they can also seem onerous to many of us. Fortunately, there are ways to avoid capital gain tax on estate property or, at least, reduce your tax bill.