Tax pitfalls of second home sales

Money Talk
By David Kilshaw
Head of private client advisory, KPMG

David Kilshaw is head of private client advisory at KPMG

The credit crunch has left some second home owners and buy-to-let investors considering whether to sell up. They should beware of the tax pitfalls, and make sure they maximise the tax opportunities.

Falling house prices, inflationary pressures and increased mortgage costs means many might consider selling.

For those lucky enough to find a buyer prepared to pay the price they want, there are some tricky tax rules to navigate when dealing with disposals of second homes or buy-to-let property.

You need to consider whether you have any capital gains tax to pay and whether you might owe any income tax on monies you may have received in rents in the past.

Capital Gains Tax

If you only have one property and you live there as your home - which is known in tax terms as your principal private residence - and you sell it, the sale is normally tax free.

If a property is not currently or has not been in the past your principal private residence, you may have Capital Gains Tax (CGT) to pay. If you buy an investment property for £150,000 and sell it for £400,000, your capital gain is £250,000.

The rate is simple. It is now a flat rate of 18% of the taxable capital gain and applies to all capital gains made after 6 April 2008.

If you sold your property before 6 April this year, it is more complicated. The date of sale is the date of exchange, not completion for tax purposes.

If you sold your property before 6 April this year, it is more complicated What is the situation for these people

For CGT purposes all taxpayers get a tax-free allowance each year which for the current tax year (2008/09) is £9,600. This can be offset against capital gains made in that year. This allowance is used once all reliefs have been applied to the gain.

But there are some features to the CGT rules which can reduce your taxable capital gain in some circumstances.

If the property was held jointly with another person, such as a spouse, then there may be another CGT allowance to add in.

If at some point in your ownership of the property, it has been your principal private residence, then you may well qualify for two potentially very valuable reliefs: principal private residence relief (PPR relief) and lettings relief.

There are no hard and fast rules regarding how long you have to live in a property in order for it to qualify as your PPR but the tax authorities will expect it to be a reasonable period and it must have been used as your principal residence - you cannot have just visited the property.

The best way to ensure that HMRC will recognise the property as your PPR is to formally nominate it as such by writing to your tax office to confirm the position.

If you have more than one property you should ideally notify the tax authorities as to which is your principal residence for this relief. This needs to be done within two years of acquiring the second residence.

Once this nomination has been made then you are free to vary it at a later date, again, you need to write to the tax authorities to do this.

Principal private residence relief operates by looking at the period of ownership. Over and above the PPR relief, there is a further allowance known as lettings relief Explanation of PPR and lettings relief

If you rented out your second home - either on a buy-to-let basis or on a holiday let - the income would have been subject to income tax.

Provided that you had declared this to HM Revenue and Customs (HMRC) and paid the right amount of tax then you should have no problems here.

The Directgov website has more information on what expenses are allowable and non-allowable against income tax on rental property.

If you are uncertain about whether you have calculated your tax liability correctly in the past, it is advisable to ask a tax professional to check your accounts for you. Most significantly, mortgage interest is an allowable deduction.

If you have any unpaid tax to declare, now's the time to do it.

Confessing to the tax authorities usually results in a lesser penalty than that which is imposed if the taxman has to come to find you - which they will as the property sale will show on HMRC's land register.

The district valuer has historically gathered information on property and land sales but with the advent of technology all property transactions can now be reviewed by the taxman in electronic format.

There are lots of tax implications to consider if selling a second home

HMRC will take an interest in the sale of second homes for both capital gains tax and income tax reasons.

If the disclosure relates to a previous tax year HMRC can potentially look at reviewing the circumstances in which the property was held, whether it was rented out, and even how it was originally paid for.

If you discover that in fact you do owe additional tax it is essential to make full and expedient disclosure. This may help reduce the penalties that HMRC can impose.

'Nasty surprise'

In today's falling market, many property investors have already had to take a hit on their portfolio's value.

The last thing that anyone wants is a nasty surprise on the tax front so it surely pays to be aware of your entitlements and to get professional advice.

If things are looking really bad and you are facing the prospect of negative equity, capital losses on assets sold at a price lower than the one paid for it can usually be claimed by the individual and can be used to set against any other capital gains that arise in the same or subsequent years.

However, such losses are not allowable on properties where a gain would have qualified for PPR.

It would usually be advisable to try to ensure that the property you plan to sell in the near distant future qualifies, at least in part, for the PPR exemption.

In a falling market you may need to consider keeping the property outside the PPR exemption, and not using it as your principal residence, if you are looking to sell, as you may want to claim the capital loss.

On the other hand, you do need to have somewhere to live.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.