Can you afford to sell an investment property?

Property is generally a good investment, and where an investment property or second home has been held for many years, it may be worth considerably more than you paid for it. It may be tempting to sell the property to release the equity, perhaps to fund retirement or to help your children get on the property ladder. However, the capital gains tax system is not kind to those who sell assets which they have held for a long time as it provides no relief for inflationary gains. Even if your property has done no more than increase in value in line with inflation, you may find that if you sell, you have to give a sizeable chunk to the taxman.

Case study

Andrew bought an investment property for £100,000 in 2003. The mortgage has now been paid off and the property is worth £300,000.

Andrew is approaching retirement and wishes to sell the property to release some funds and also to give some money to his two children to help them with a deposit so they can each buy a property. However, if Andrew sells the property, he will incur a chargeable gain.

If it is assumed that the costs of sale and purchase are £10,000, Andrew will realise a gain of £190,000. If the sale completes before 6 April 2023 and he has not realised any other gains in the year, he will be able to set his 2022/23 annual exempt amount of £12,300 against the gain, reducing the chargeable gain to £177,700.

Andrew is a higher rate taxpayer. He must therefore pay capital gains tax on the chargeable gain at the rate of 28% – a tax bill of £49,756. The gain must be reported to HMRC and the tax paid within 60 days of completion.

The annual exempt amount reduces to £6,000 for 2023/24. Consequently, if the sale does not complete until after 5 April 2023, the chargeable gain will be £184,000 and Andrew’s tax bill will be £51,520.

Although in real terms there has been no increase in value – the property price has simply kept pace with the market – the tax system does not recognise this. There is no longer any relief for inflationary gains meaning that those selling a property that they have owned for a long time are likely to face a large tax bill.

After paying the tax, Andrew is no longer able to afford to repurchase the asset he has just sold.

Alternatives

Rather than selling the property, Andrew could consider remortgaging the property or undertaking an equity release to provide the cash to fund his retirement and help his children. However, this comes at a cost, and as interest rates rise, the costs will increase. If the property is let out, it may be that the rent will be sufficient to cover the borrowing costs. However, it should be remembered that the rent is taxable at Andrew’s marginal rate (which, if he is a higher rate taxpayer, is 40%). Further, if the property is a residential let, relief is only available for interest costs as a basic rate tax deduction.

Where the capital gains tax hit of selling is high, it is advisable to consider alternatives. However, there is no substitute for doing the sums.