Can I use my holiday home to thwart the taxman?
Q: We own a holiday cottage that we rent out and may sell in two or three years' time. But before we do, we're thinking about selling our own home and living in the holiday property for at least six months and using it as our home in order to avoid paying capital gains tax (CGT). It would then be our 'principal residence' at the time of selling. In fact, it would be our only one. Can you offer any further suggestions or point out any pitfalls in this plan?
A: Charles Hutton is a partner at Speechly Bircham specialising in inheritance tax planning
Any gains made from the sale of your main home are exempt from CGT as it is viewed as your primary residence, whereas gains from assets such as secondary properties are taxable.
However, there are certain conditions that need to be satisfied, and sometimes the exemption is only available for part of the gain.
If you sell your own home and move to the cottage for, say, six months, and occupy it as your sole residence, then the last three years of your ownership should be exempt from CGT.
This is because the last three years are always exempt if the property has been your main residence at some point.
Let's say that you acquired the cottage in January 2001 for £100,000 including costs, spent£20,000 on improvements and then sell it in January 2011 for £200,000 (after deducting the costs of the sale). Let's also assume that you occupy it as your residence for six months before you sell it.
The gain on these figures would be £80,000. The exemption would then extend to three-tenths of the gain (the last three years divided by the total period of ownership), making the chargeable gain £56,000.
It's a proportion of the overall gain that's exempt: you don't need to work out what the property was worth in January 2008 (three years ago) and then the gain before and after that date.
From the chargeable gain you can deduct your annual CGT allowance of £10,100, assuming you haven't already used it. Following the Emergency Budget, if you are a higher-rate taxpayer, the new CGT rate is 28%, while lower-rate taxpayers still pay 18%.
If the property is jointly owned, you can both deduct your allowances. Assuming joint ownership, this would make the taxable gain £35,800. CGT would be payable on that at 18% (assuming you're a lower-rate taxpayer), giving a tax charge of £6,444, or £10,024 as a higher-rate taxpayer.
For the exemption to be fully available for the last three years, no part of the property must be used exclusively for business purposes during the six months you live there. Furthermore, no part of the property should be let during that period.
The general rule is that garden and grounds of up to half a hectare (plus the site of the house) are included within the exemption. A greater area may often be included, provided it's of a character appropriate to the property.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.