The tax rates on gains made from selling a residential property are 40% or 80% higher than those for other types of gain. How can you use an HMRC approved tax break to reduce your tax bill?
Residential property gains
In 2016 the government slashed the rates of capital gains tax (CGT) for individuals from 28% to 20% for higher rate taxpayers and 18% to 10% for basic rate payers. The bad news is that the reductions don’t apply to taxable gains made on residential property. To make matters worse for property owners, tighter rules for private residence relief (PRR) on gains from the sale of homes mean that you’re increasingly likely to face CGT at the higher rates.
Traditional tax planning
The good news is that there are simple ways to reduce CGT. For example, if you own the property by yourself, transferring a share to your spouse or civil partner shortly before you sell it means two annual exemptions to reduce the gain on which CGT is payable. Using this tactic there are further savings where your spouse/partner pays CGT on their share of the gain at 10% where you would pay at 28%. If transferring a share of the property won’t result in CGT savings for you, there’s an alternative that can work in almost all situations.
Planning: Putting money into an enterprise investment scheme (EIS) investment can reduce your CGT rate from 18% to 10% and reduce your tax in other ways.
EIS planning
Investing all or part of the gain you make from selling or transferring a residential property in an EIS investment means you can claim CGT “deferral relief”. The effect of this is, as the name suggests, to defer when the gain is taxed. The deferral continues until the tax year in which you sell the EIS investment. While deferring tax is good, the real magic happens when the deferred gain becomes taxable. When this happens it’s transformed from being a property-related gain, and so liable to the 18% and 28% CGT rates, to a general gain to which the normal 10% and 20% rates apply.
Planning: The other CGT saving measure is that shifting a share of the gain to your spouse/partner can be used to reduce the tax due on the gain when triggered by the sale of the EIS investment.
Planning: EIS investments also come with generous income tax relief. You must own the investment for at least three years or the relief is lost. However, the three-year retention period doesn’t apply to deferral relief. Remember that EISs are higher risk investments (see The next step ).
Example. Mark, a higher rate taxpayer, sold his flat in March 2022 making gain of £80,000. He owned it for exactly ten years but only lived in it for one. Thereafter it was let. PRR applies to 19/120 of the gain, i.e. £12,667, leaving £67,333 taxable. After deducting his annual exemption Mark owes CGT of £15,409 (£55,033 – £12,300) x 28%. Mark invests £55,000 in an EIS investment and claims deferral relief. This allows him to defer the gain from being taxable until he sells the EIS investment , which he does several months later. As that’s in the next tax year he can deduct his annual exemption to reduce the taxable amount to £42,700 on CGT at 20%, resulting in a tax bill of £8,540. Mark has saved tax of £6,869.
You can defer a capital gain indefinitely by investing an amount equal to the gain you made in an enterprise investment scheme investment. Tax can be saved because when the deferred gain becomes chargeable it is no longer treated as a property gain. Therefore the higher capital gains tax rates don’t apply.