Capital gains tax, equity release and CGT calculation

Question:

I am a higher rate tax payer and have a PAYE job earning around £100,000 per year.

I also own a buy to let property which was bought in 1995 for £85,000. It's now worth in the region of £320,000.

I am married but the property(s) are held just in my name.

My property has an interest only mortgage of £140,000 secured against it. The mortgaged funds were used as deposits for other BTL properties. I want to access an additional £180,000 to finance further Buy to let property purchases.

If I borrow 100% of the property value and use this then would this mean that I could avoid CGT on the complete gain when the property was sold.

Questions for WealthProtectionReport.co.uk:

1. Is the above correct? 2. How do I demonstrate an auditable trail that demonstrates that funds raised on one property have been used to pay off another property especially when I come to sell.

For capital gains tax purposes the impact of the mortgage is essentially ignored.

Therefore whether you dispose of the property now to realise the equity or were able to find a lender that would provide a 100% mortgage over the property the tax position on a disposal of the current property would be the same and a gain would arise based on the uplift in value from the acquisition date to the disposal proceeds. The extent that the property is leveraged would be irrelevant for CGT purposes.

If you were to dispose of the property, the capital gain arising would be calculated as:

Proceeds £320,000
Acquisition cost (85,000)
Gain 235,000
Annual exemption (9,600)
Chargeable gain 225,400

The CGT charge would be in the region of £40,500.

You could consider transferring a half interest in the property to your wife. This would allow her annual exemption to be utilised.

If you/your wife were to consider occupying the property prior to a disposal you could potentially claim principal private residence ('PPR') relief and lettings relief on the disposal.

Where an individual has occupied a property as a residence for only part of his period of ownership then a proportion of the capital gain resulting on the disposal of the property is exempt. This is calculated on the following basis:

Capital gain x period of occupation/period of ownership

In addition to the period that an individual actually occupies a property as his residence, when calculating the period of occupation there are certain deemed periods of occupation which are allowed to be taken into account.

In your case the last 36 months of ownership would be deemed to be occupied by you irrespective of whether you actually occupied the property during this period. Please note that this relief will only apply where the property has been your main residence at some point during your ownership.

Where a property is let on an exclusive basis then clearly the owner individual will not be able to establish the property as his main residence for this period. However, a form of relief ('lettings relief') is available.

An exemption from capital gains tax is granted for that part of the gain attributable to the letting in so far as it does not exceed the lower of:

• the tax free part of the gain under the PPR relief
• £40,000

By way of an example, if you were to occupy the property as a main residence prior to a disposal in 2009, and ensure that an interest was transferred to your wife, the approximate CGT charge could be reduced to £20,500 (ie reduced by around half).

Therefore in summary, releasing equity in the property would not effect the CGT calculation, The key impact here would be to try and ensure that any increase in debt was used to purchase or enhance rental properties. This should then ensure than an income tax deduction is available for the interest on the mortgage. In order to demonstrate, this wherever possible a separate rental account should be used for the rental income/expenditure and the proceeds from the equity release should be credited to this account prior to purchasing the new rental property.

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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