Maximise CGT private residence relief with careful planning

September 28, 2018|In KRW Tax Tips|By Keith Witchell

Rental property owners that live in the property for a period of time may be able to mitigate their potential Capital Gains Tax liabilities on an eventual sale through careful planning.

If you own a buy-to-let property and live in the property as your only or main home for a period of time you will be entitled to some private residence (PR) relief from Capital Gains Tax when you come to sell it.

In such cases, when calculating the Capital Gain on the sale of the property the period that you lived in the property, plus your final 3 years of ownership are exempt from Capital Gains Tax. In addition, you will be entitled to a letting relief which exempts (up to) a further £40,000.

However, in some cases it can be possible to achieve an even better result by a carefully timed transfer of the property between spouses.

This is best explained with an example:

Harry purchases a buy-to-let property in London for £115,000 in 1990, and rents it out. In 2018 he decides to downsize and puts his country house on the market, with the plan being to move into the London property with his wife. They then intend to live there for around 5 years before retiring and emigrating to Australia.

Assuming everything goes to plan, Harry will end up selling the London property in 2023 when it should fetch £1 million. He will have owned the property for 33 years by then so only the final 5 years of ownership (in which he will have lived in the property as his only or main residence) will attract the PR exemption, plus a further £40,000 of letting relief.

He would therefore be taxed on 28/33rds of the gain of £885,000, less £40,000 of letting relief which gives a potential Chargeable gain of £710,909. After offsetting his annual exemption he will be left with a taxable gain of c.£700,000 which will be taxed at 28%, giving him a liability of £196,000.

However, if Harry had transferred the property to his wife (inter-spouse transfers of assets are exempt from Capital Gains Tax) before they moved into the London property in 2018 he could have wiped out the tax liability completely!

The reason for this is that when a private residence is transferred between spouses, the acquiring spouse takes over the donor spouse’s base cost and usually also their ownership period so that they effectively stand in the shoes of the donor spouse for Capital Gains Tax purposes.

A little known quirk to these rules is that for the ownership period to be transferred, the following must apply at the time of the transfer:

(a) the couple must be married and living together; AND
(b) the property in which the interest is being transferred must be their sole or main residence.

As a result, condition (b) can be broken by Harry transferring the property into his wife’s sole name BEFORE they move into it. As a result, Harry’s wife would take over Harry’s base cost of £115,000 but not his ownership period. She would therefore only own it from 2018 onwards and providing the couple live in it as their only or main residence from 2018 to 2023 then all 5 years of her ownership will attract the PR exemption, making the entire gain exempt from Capital Gains Tax.

For further advice on this matter, please contact me.

Keith Witchell