Can you solve a capital gains issue with a lifetime mortgage?

Capital Gains Tax on property – the basics

Let’s start with some good news - your main home will not usually attract Capital Gains Tax (CGT) when you sell it because this property will benefit from “private residence relief”. So, you can keep all of the profits when selling your home.

If you have a second home, holiday home or rental property and you sell it for more than you bought it for then you may need to pay Capital Gains Tax on the difference.

For the tax year 2018/2019 each person has a CGT tax-free allowance of £11,700 and if not used in the tax year this cannot be carried forward.

For residential property a basic rate tax payer will pay CGT at 18% within the basic Income Tax Band and if you are a higher or additional rate tax payer this increases to 28%.

If you have more than one home you can nominate which will be tax free. This nomination has to be done within two years of acquisition.

Can you avoid Capital Gains Tax on second properties?

There are increasing numbers of people owning more than one residential property. For some this has been a deliberate strategy and for others less deliberate, perhaps an inheritance and they have decided to retain the property.

These properties are either rented out or used as second homes or holiday homes. At some point the decision may be taken to sell the property – the proceeds of sale to be used for many different purposes. However, this can on many occasions crystalise a capital gain and provide a capital gains tax liability of up to 28%. For example a property purchased in 1992 for £125,000 with a value today of £525,000 would see a capital gain of £400,000 and potential capital gains tax up to 28%, which in this case is £112,000. This is a substantial cost and certainly worth considering other options in order to mitigate this liability.

Sale of the main residence to raise funds without attracting CGT could be an option for some. However, this is not always that straight forward and there are often many very good reasons why people prefer to stay in the main family home. 

The overall mortgage market has seen increasing product developments and flexibility where buy to let mortgages can be taken out well into later life. There are also equity release lifetime mortgages available on buy to let properties and requiring no payments.  These mortgages can be used for any purpose; interest can be rolled up if required on a lifetime fixed interest basis.

Using these buy to let or lifetime mortgage products in this way can avoid the need to sell the property. Therefore, the client can continue to benefit from any rental income and capital appreciation from the property. The property does not need to be sold and thus avoids what can be a substantial capital gains tax bill.

Case study

Mr and Mrs C own their home without a mortgage and it has a current value of £650,000. Following the death of her mother 22 years ago Mrs C inherited her mother’s property which they decided not to sell and to rent it out. The property has good tenants, a professional family and they pay a monthly rental of £1,950 per month. They have decided to sell this property to allow money for gifts to close family members and help with some care costs. The value when inherited was £220,000 and this has increased today so that it is now worth £495,000.

The potential capital gains tax liability at 28% is £77,000. 

As an alternative, the couple could raise a mortgage on this property of £200,000. They can use the rental income to cover the mortgage interest if they wish or allow the interest to roll up – their choice and a decision that may change depending on their needs and circumstances or perhaps depending on any health issues.

They continue to benefit from any capital appreciation to the property. They avoid the capital gains tax issue and when they both pass away; the mortgage will be a debt against their estate and help to reduce any inheritance tax liability.
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