Do you have a second home? You might want to sell up before April 2020!

Private residence relief and the final period exemption

From a capital gains tax perspective, there are significant tax savings to be had if a property has been the owner’s only or main residence. The main gains are where the property has been the only or main residence throughout the whole period of ownership as private residence relief applies in full to shelter any gain arising on the disposal of the property from capital gains tax.

However, there are also advantages if a property enjoys only or main residence status for part of the ownership period; not only are any gains relating to that period sheltered from capital gains tax, but those covered by the final period exemption are also tax-free.

The final period exemption works to shelter any gain arising in the final period of ownership from capital gains tax if the property has at any time, however briefly, been the owner’s only or main residence. This can be particularly useful if the property is, say, lived in as a main home and then let out prior to being sold, or where a person has two or more residences.

Prior to 6 April 2020, the final period exemption applies generally to the last 18 months of ownership. Where the person making the disposal is a disabled person or a long-term resident in a care home, the final period exemption applies to the last 36 months of ownership.

From 6 April 2020, the final period exemption is reduced to nine months, although it will remain at 36 months for care home residents and disabled persons.

Planning ahead

Where a property which has been occupied as a main residence at some point, it could be very advantageous to dispose of it prior to 6 April 2020 rather than after that date to benefit from the longer final period exemption.

Example

Frankie has a cottage on the coast that he brought on 1 January 2010 for £200,000. He lived in it as his main residence for two years until 31 December 2011, when he purchased a city flat which has been his main residence since that date. He continues to use the cottage as a holiday home.

He plans to sell the cottage and expects to get £320,000.

Scenario 1 – sale on 31 March 2020

If Frankie sells the cottage on 31 March 2020, he will have owned the cottage for a total of 10 years and three months (123 months). Of that period, he lived in it for 24 months as his only or main residence. As the sale takes place prior to 6 April 2020, he will benefit from the final period exemption for the last 18 months.

The gain on sale is £120,000 (£320,000 – £200,000)

He qualifies for 42 months’ private residence relief, which is worth £40,976 (42/123 x £120,000).

The chargeable gain is therefore £79,024 (£120,000 – £40,976).

Scenario 2 – sale on 30 April 2020

If Frankie does not sell the property until 30 April 2020, he will only benefit from a nine-month final period exemption. If he sells on this date, he will have owned the property for 124 months. Assuming the sale price remains at £320,000 and the gain at £120,000, the gain which is sheltered by private residence relief is £31,935 (33/124 x £120,000), and the chargeable gain is increased to £88,065 (£120,000 – £31,935).

If planning to dispose of a property which has been an only or main residence for some but not all of the period of ownership, selling prior to 6 April 2020 will enable the owner to shelter the gain pertaining to the last 18 months of ownership.

Partner note: TCGA 1992, s. 223; Draft legislation for inclusion in Finance Bill 2019—20 (see Changes to ancillary reliefs in Capital Gains Tax Private Residence Relief – Draft Legislation).

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If you need help on how to time dividends, read our short article that explains the basics

Timing dividends right could help save tax

Timing the date of a dividend payment from a company can determine both the amount and the due date of the tax payable. This may be a particularly useful strategy in a close- or family-owned company.

The dividend allowance, which was originally introduced from 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. Fortunately, the tax rates on dividend income, above the allowance, remain at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

The amount of tax payable on dividend income is determined by the amount of overall income an individual receives during a tax year. This includes earnings, savings, dividend and non-dividend income. The amount of dividend tax paid depends primarily on which tax band the first £2,000 falls in.

Accelerating payment

The timing of the dividend payment may have a marked impact on the directors’ and shareholders’ personal tax situation. A dividend is not paid until the shareholder receives the funds direct or the dividend amount is put unreservedly at his or her disposal, for example by a credit to a loan account on which the shareholder has the power to draw. If the personal tax allowance and basic rate band for a tax year have not been fully utilised towards the end of the tax year, payment of a dividend may mean that the unused portion can be mopped up.

Example

Graham is the sole director and shareholder of a limited company.

He is considering whether to pay a dividend before the end of the 2019/20 tax year. In that tax year he has other income of £25,000. He has retained profits in the company of £100,000.

For 2019/20 the personal tax allowance is £12,500 and the basic rate tax band is £37,500. The dividend allowance is £2,000.

If Graham pays a dividend of £27,000 before the end of the 2019/20 tax year, he will fully utilise his basic rate band, and will be liable to tax at 7.5% on the £25,000 of the dividend income (the first £2,000 of the dividend being covered by the dividend allowance).

Delaying payment

Where the shareholder already has income exceeding the basic rate band in one tax year, delaying the dividend until the start of the next tax year could save tax.

Example

Following on from the above example, say Graham has already paid himself a salary of £50,000 in the 2019/20 tax year, thus fully using up his basic rate band. If he pays the £27,000 dividend before the end of the tax year, he will pay tax on it of £8,125 (£27,000 – £2,000 allowance x 32.5%). This tax will be due for payment on 31 January 2021.

If he waits until the start of the next tax year (2020/21) to pay the dividend, and also receives a salary of £25,000 during that year, the tax due on the dividend will be £1,875 (£25,000 x 7.5%) – a potential saving of £6,250. Graham will also benefit from a delay in the due date for payment of the tax until 31 January 2022.

Fluctuating income

Dividend payments can often be timed to smooth a director/shareholder’s earnings year-on-year. Broadly, where profits fluctuate, a company could consider declaring and paying dividends equally each year, or by declaring a smaller dividend in the first year (when profits are higher) and treating the remainder of the payment as a shareholder loan. At the start of the next tax year, a further (smaller) dividend can be declared, which will repay the loan. Care must be taken with this type of arrangement, not least because the loan must be repaid within nine months of the company’s year-end to avoid a tax charge arising on the company.

The family business potentially offers considerable scope for structuring tax-efficient payments to family members using a mixture of both salary and dividends. A pre-dividend review may be particularly beneficial towards the end of the company’s year-end.

Partner Note: ITA 2017, s 8 and s 13A; F(No 2)A 2017, s 8;  CTA 2010, s 455

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