A Guide to the Capital Gains Tax on UK Property
The United Kingdom is a popular destination for American expats. As such, more and more Americans are purchasing homes there. Since Brexit, the United Kingdom has seen declines in the value of its currency and home prices, both of which affect property owners. While the housing market may be stagnant at the moment, upcoming changes to the capital gains tax on UK property could dramatically improve your bottom line when selling a rental or vacation home.
What Is Capital Gains Tax in the UK?
As it relates to residential properties and United Kingdom tax residents, the capital gains tax (CGT) is assessed on any gain on the sale of a second home (i.e., a vacation home or rental), as well as on the sale of your main home if you’ve rented it out, used it for business purposes, or it’s larger than approximately one acre (including the land). The amount of the taxable gain is typically determined by taking the sales price minus the purchase price of the home, and the tax rate can range from 18-28%.
Capital Gains Tax Allowance on UK Property
In the UK, there is a tax-free allowance of GBP 12,000 per taxpayer on capital gains. In other words, capital gains up to GBP 12,000 are not taxable in the United Kingdom. Note that if a married couple jointly owns a property, each of them will receive the GBP 12,000 allowance toward their share of any gain on the sale.
Tax Relief on Private Residences
You are not required to pay capital gains tax in the UK on the sale of your main home if you’ve lived there for the entire time you’ve owned it, you have not rented it out, you have not used part of it for business only, the total size of the property is less than approximately one acre, and you did not buy it for the sole purpose of selling it for a gain. This is known as the principal private residence relief (PPR), and in the case that you do qualify, there is no need to disclose the sale to the HMRC.
Relief is also available to those UK residents who have rented out their home. Current law allows for homeowners who lived in their home before renting it out to claim CGT relief on the sale for up to 18 months after they move out. This is known as the final period exemption.
Letting relief has historically been another avenue to reduce CGT. Under current tax law, if a resident sells their former home after having rented it out, GBP 40,000 of the gain is exempt from capital gains tax in the UK. If the home is owned by a married couple, the joint exemption is GBP 80,000.
When to File & Pay Capital Gains Tax in the UK
Capital gains were reported on the self-assessment tax return, and any resulting tax would have been paid by January 31st of the following year. As an example, under current law, if a United Kingdom tax resident sells his vacation home on June 1, 2018, then the sale and any resulting gain would be reported on the 2018/19 self-assessment and tax would be payable by January 31, 2020.
As of April 6, 2020, the final period exemption is reduced from 18 months to only 9 months. Additionally, the letting relief will now only be available to those United Kingdom residents who lived in the home as their main home over the entire time the home was rented, along with their tenants.
A 30-day reporting and payment window will be implemented on taxable property disposals or transfers for United Kingdom tax residents (even if no money changes hands – gifted, for example). In other words, within just 30 days of disposing of a property, a “payment on account” return will need to be filed with HMRC along with payment of the CGT due. Note that the 30-day period is already effective for nonresident landlords. Those individuals are required to report all sales no matter if the transaction results in a gain or loss. Failure to pay the CST within 30 days will result in penalties and interest.
How Does This Differ From US Capital Gains Tax?
If you are a US citizen or permanent resident, your worldwide income is taxable in the US. Therefore, if you’ve purchased a home in the United Kingdom and later sell it, you’ll need to report that sale on your US income tax return. Keep in mind three main transactions for US purposes: the capital gain on the sale itself, depreciation recapture in the case of a rental property, and the potential for a foreign currency exchange rate gain.
Unlike the United Kingdom CGT, sales of properties are reported in the US on the annual income tax return for the year in which the sale occurred. Any capital gains tax related to the sale would be due at the same time the tax return is due.
Exemptions for Capital Gains Tax on US Property
In terms of relief or exemptions, IRC Section 121 allows for a potential gain exclusion of $250,000 per taxpayer ($500,000 for joint couples) on the US income tax return if the taxpayer(s) owned and used the home as their primary residence for two of the five years preceding the sale. If the property was also rented out, the potential exclusion would be prorated based on qualifying and non-qualifying use. Note that the IRC Section 121 exclusion applies only to primary residence sales and can only be utilized once every two years unless special circumstance apply like job changes, health changes, etc.
In the case of a property that has been rented out, the amount of depreciation claimed or claimable for US tax purposes will be recaptured as income and taxed at a flat 25% to the extent there is a gain on the sale of the property.
Foreign Exchange Rate Gains
Finally, and perhaps the most important point relating to United Kingdom property sales after Brexit, is the foreign exchange rate gain. Simply put, if it takes fewer US dollars to pay off the mortgage on the property than it took to take the mortgage out, the difference is taxable as ordinary income. If the reverse is true, the loss is unfortunately not deductible. Note that while mortgage payoffs typically take place at the time a property is sold, they can actually take place at any time.
What About Double Taxation as it Relates to Capital Gains Tax in the UK?
In the case of an American citizen or permanent resident that sells a UK property while a United Kingdom tax resident, the sale will be reported in both countries. You can, however, claim a foreign tax credit to alleviate double taxation on the sale.
Let Us Help You Get Your Taxes Right!
Property sales are complex and often have far-reaching tax consequences. Hopefully, the above information gave you a starting point for upcoming changes in the United Kingdom capital gains tax on the sale of homes and provided a helpful comparison to US tax rules related to such sales. But, the best option is to leave your taxes in the hands of professionals. Get started with Greenback today!