Residential property and CGT – planning for the increase

Capital Gains Tax is going up.

Whether you own a second home or a portfolio of buy to let properties, these are worrying times. The government will reveal full details in the emergency budget on 22 June but everything suggests a new CGT rate for top earners of up to 40% or even 50%. That’s more than double the current rate of 18% which, by historic standards, is exceptionally low for property owners and investors.This note explores what planning can be done now to beat the increase.

When will the new rules apply?

Any changes are likely to take effect either on budget day or on 6 April 2011. Even a retrospective change is possible although unlikely. Whilst the lack of certainty makes planning difficult, we still believe it is sensible to assume a budget day increase on 22 June and plan for that. If you take action now, the potential tax savings could be very significant compared to the cost of doing nothing.

What planning can be done now?

The key to any planning is to dispose of your property now. You will then lock in the current rate of 18% before potentially higher CGT rates apply. If a sale is already in progress then you should try to complete the sale, and certainly exchange contracts, before the budget. But for most people, a sale to a 3rd party before 22 June will be impractical. In that case you can still trigger a pre-budget disposal for tax purposes by transferring the property to a connected party such as a family trust. There is nothing to stop you benefiting from the trust and you can even be a trustee so that you still keep control.

What are the advantages?

A disposal to a family trust is taxed like an actual sale at today’s market value. That means you pay tax at just 18% on all gains to date. If those historic gains are large, the tax saving could be very significant compared to paying tax at up to 40% or even 50%. Locking in today’s tax rates is particularly attractive if you expect to sell the property in the next few years. In that case only future gains would be taxed at the new higher rates.

Are there any disadvantages?

A disposal to a family trust means the tax will ordinarily be payable on 31 January 2012 even though the property might not have been sold by then. However, you can usually pay the tax in ten annual instalments.

The other potential downside is the risk of having to pay tax on current gains which may never actually be fully realised. The tax liability remains even if the property subsequently falls in value or is never sold.

What if there is no sale on the horizon or the property falls in value?

Fortunately there is a solution. It still involves a disposal to a family trust to lock in today’s lower CGT rates. However, the disposal is structured in such a way that if circumstances change, there is a mechanism to unwind the disposal and avoid the CGT charge.

Who should consider pre-budget planning?

Planning for an imminent increase in CGT is relevant for the following:-

• Individuals (or trustees) who own a second home in the UK or abroad
• Buy to let investors
• Those currently selling, but where contracts will not be exchanged before 22 June.

IMPORTANT: This Update is only intended as a general statement and no action should be taken in reliance of it without specific legal advice. For further information on possible CGT planning before the emergency budget on 22 June, please contact either:

Andrew Goldstone on 020 7440 7205 or Jonathan Legg on 020 7440 7092.