Second home owners could face a significant tax charge on gains made from the sale of their properties after the Treasury moved to limit 'flipping' of primary residences for tax purposes.
Officials are consulting on a change that would mean UK residents with two homes would no longer be able to elect a main residence that is exempt from capital gains tax. Instead the main residence would be decided by HM Revenue & Customs.
Currently, those with more than one property have free rein to elect any of them to qualify for 'private residence relief'. This relief means profits they may make when they sell it are free of CGT.
Town & Country: Changes to Private Residence Relief could hit those who 'flip' homes to reduce their tax bill.
The rules as they stand give relief from tax on profits made in the previous three years. This has allowed owners of multiple homes to 'flip' their main residence so that more than one qualifies for the relief and they can reduce the tax charge when they sell.
The election must be made within two years of acquiring the second home. Landlords cannot elect a rental property to be their main residence.
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The Government has already moved to reduce the relief, announcing in December's Autumn Statement a cut to the grace period from three years to 18 months, coming into force from 6 April.
However, a Treasury and HMRC consultation paper on the treatment of non-residents, published last week, contained proposed changes that would also change the rules for UK residents.
The Government wants to make non-residents pay tax on their UK property profits for the first time. To do so, it needs to remove the ability for non-residents to elect a UK home as their main property, as would be possible under current rules. However, it also means removing it for UK residents.
Capital gains tax is payable on profits from the sale of assets.
It is charged at a rate of 18 per cent if you are a standard-rate taxpayer or 28 per cent if you pay tax at the higher rates.
No one has to pay CGT on their home so anyone with just one house will never pay it when they sell.
Those with two or more will pay the tax on profits from sales of properties other than their main residence.
Everybody has an amount they can make each year that are exempt from CGT, For 2013/14 the level is £10,900.
The change will be significant for those with two homes, according to Patricia Mock, a tax director at Deloitte. She said: 'Lots of people in this position change the election of their main residence to whichever they feel will be sold at the bigger gain.
'Changing this will be significant and will create a lot of extra work for the taxman. It's not exactly clear how they will keep on top of it. Imagine a situation where a person lives in London for the week but in the country for the weekend, it would be a big ask to keep records to show where is being used the most.'
Officials have proposed two ways to decide a persons main residence. The first removes the ability of individuals to elect a property with the HMRC instead making the decision based on all the available facts.
This process is already used by the taxman where individuals make no election of their main residence.
The decision is not based solely on where an individual spends their time, but also factors such as where children live and attend school, where the individual is registered to vote, which property is the contact for bank and utility correspondence and where the person is registered with a doctor.
The second proposed method would be based on how an individual splits their time, with main residence status given to the home where they have been most present for any tax year.
This second method could require individuals to keep different or additional records, officials admitted.
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A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
Converting Flipping Houses Into A Primary Residence
If you live in a property for at least 2 years, you can exclude up to $250,000 (or $500,000 if married filing jointly) of the capital gains from the sale of your primary residence from being taxed.
For the IRS to consider a second home a personal residence for the tax year, you need to use the home for more than 14 days or 10% of the days that you rent it out, whichever is greater. So if you rented the house for 40 weeks (280 days), you would need to use the home for more than 28 days.
The IRS considers the profits of flipping houses as ordinary income, meaning that you pay taxes within your normal income tax rate. You'll have to pay a self-employment tax, which typically is a rate of 15.3%. You will also pay federal income taxes and state income taxes, again at your ordinary income tax rate.
An easy and impactful way to reduce your capital gains taxes is to use tax-advantaged accounts. Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes at all on the assets in the account.
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
Second, capital gains taxes on accrued capital gains are forgiven if the asset holder dies—the so-called “Angel of Death” loophole. The basis of an asset left to an heir is “stepped up” to the asset's current value.
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
Investing in retirement accounts eliminates capital gains taxes on your portfolio. You can buy and sell stocks, bonds and other assets without triggering capital gains taxes. Withdrawals from Traditional IRA, 401(k) and similar accounts may lead to ordinary income taxes.
After all, you can significantly reduce the cost of owning a second home by claiming tax deductions for mortgage interest, property taxes, and rental expenses. The Tax Cuts and Jobs Act (TCJA) changed how tax breaks work, in ways such as reducing the mortgage interest deduction.
The IRS prohibits married couples from claiming two primary residences for tax purposes. The designation of a primary residence, or “main home,” holds significant importance for homeowners due to the array of tax benefits tied to this status.
When you sell a vacation home, rental, fix-and-flip, or any second property that is not your primary residence, you will typically be responsible for paying capital gains taxes on any profits you make, at a rate of up to 20%, depending on your tax bracket. But you may be able to mitigate those taxes.
The 70% rule helps home flippers determine the maximum price they should pay for an investment property. Basically, they should spend no more than 70% of the home's after-repair value minus the costs of renovating the property.
Usually, when someone flips a property, he or she makes repairs and improvements beforehand. It can become illegal if the person falsely represents the condition and value of the property. This equates to fraud, which carries serious consequences.
In terms of the flip itself, expenses the investor has like the cost of materials needed for the actual renovation, and the cost of labor on the property can be deducted. If you're a fix and flip investor, and you sell your property in under twelve months, then capital gains tax will apply to the income you make.
Is there a way to avoid capital gains tax on the selling of a house? You will avoid capital gains tax if your profit on the sale is less than $250,000 (for single filers) or $500,000 (if you're married and filing jointly), provided it has been your primary residence for at least two of the past five years.
Current tax law does not allow you to take a capital gains tax break based on age. In the past, the IRS granted people over the age of 55 a tax exemption for home sales. However, this exclusion was eliminated in 1997 in favor of the expanded exemption for all homeowners.
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