Capital Gains Tax and How It Works Explained

Capital Gains Tax and How It Works Explained

Capital Gains Tax is one of the most overlooked parts of property ownership, yet it can have a significant impact on your profit when selling a home, rental property, or investment. Capital gains taxes apply to a wide range of capital assets, not just property, and are governed by specific tax rules that define taxable events, rates, and exemptions.

As a mortgage broker, I regularly speak with clients who are planning to sell property or restructure their portfolio and want to understand how capital gains tax works, what they might owe, and how they can plan ahead to reduce their liability.

In this article, I’ll break down everything you need to know in clear, practical terms including how capital gains tax is calculated, what counts as a “gain,” how property is treated differently from other assets. The exemptions and reliefs that could help you reduce your bill. Changes in the autumn budget can impact capital gains tax rates and allowances, so it’s important to stay informed about the latest updates.

What Is Capital Gains Tax?

Capital Gains Tax (CGT) is a tax you pay on the profit or “gain” you make when you sell (or “dispose of”) an asset that has increased in value. A capital asset can include properties, shares, and other taxable assets. You are taxed only on the gain, not on the total sale price.

This applies to many assets, including shares, antiques, cryptocurrency, and most importantly for property owners, investment property and second homes. The market value of these assets is used to determine the gain for tax purposes.

The key point is that your main residence is generally exempt from capital gains tax, thanks to what is known as Private Residence Relief. This exemption applies to your principal residence, while other taxable assets may not qualify for such relief. However, if you own rental property, holiday lets, inherited property, or any second home, capital gains tax becomes a critical factor.

When Does Capital Gains Tax Apply to Property?

Not every property sale triggers capital gains tax. CGT typically applies when you sell a residential property that is not your main home.

Your total income for the year can affect how much tax you pay on your taxable gains from selling residential property.

You may pay capital gains tax when you sell:

• A buy-to-let property
• A holiday home
• A second residence
• A property you have inherited and later sell
• A home that was previously your main residence but used for rental or business (Note: Capital gains tax may also apply to other assets sold, such as shares, antiques, or other investments.)

You usually don’t pay CGT when you sell:

• Your main residence, assuming full Private Residence Relief applies

Tax reliefs, such as Private Residence Relief, can exempt your main home from Capital Gains Tax (CGT). Additionally, allowable losses from previous sales may also reduce your overall tax liability.

However, if you have ever let out part of your home, used a room exclusively for business, or lived away from the property for long periods, a portion may become taxable.

These scenarios are more common than people think, and planning ahead can save thousands.

How Capital Gains Tax Is Calculated on Property

The calculation itself is straightforward: your capital gain is determined by subtracting the original purchase price and any incidental costs (such as legal fees, estate agent’s fees, and broker commissions) from the sales proceeds. Several steps are involved.

You can deduct certain costs from your gain, including the purchase price, improvement costs, and incidental costs related to buying and selling the asset. These deductions are important for tax purposes, as they reduce your overall capital gain and, consequently, the amount of tax you may owe.

Step 1: Work out the gain

This is the difference between:

• What you sold the property for

minus

• What you originally paid for it

You can also deduct buying and selling costs such as:

• Estate agency fees
• Broker fees
• Legal fees
• Stamp duty paid at the time of purchase
• Capital improvement costs (extensions, conversions, structural work)

General maintenance (like painting or repairs) does not reduce the gain.

If you sell an asset within a year, the profit may be considered a short-term capital gain and could be taxed at a higher rate. If you hold the asset for more than a year before selling, it may qualify for long-term capital gain treatment, which often has tax advantages.

Note: Unrealised capital gains, gains on assets you haven’t sold yet, are not subject to tax until the asset is actually sold.

Step 2: Apply the annual allowance

Everyone has an annual exempt amount (also known as the annual exemption or tax free allowance) for Capital Gains Tax (CGT) each tax year, which is the amount of gain you can make before paying CGT. Only gains above this allowance are taxed. The annual exempt amount is adjusted annually by the government.

Step 3: Apply the correct tax rate

Capital gains tax on property is charged at different tax rates, including CGT rates and income tax rates, depending on your total capital gains and total income for the year. The applicable rates can vary based on your tax bracket and the type of asset sold.

• A basic-rate taxpayer
• A higher-rate taxpayer

Property is taxed at a higher CGT rate than other investments, and changes in the autumn budget can affect these rates.

This is why planning ahead particularly for landlords is crucial.

Capital Gains Tax on Buy-to-Let Properties

One of the most common questions I receive as a broker is: “Do I pay capital gains tax when selling my buy-to-let?”

In most cases, yes.

Because buy-to-let properties are not your main residence, they fall fully within the CGT regime. Rental income from these properties is taxed separately from capital gains, and landlords must ensure they are paying tax on both.

The more the property has grown in value, the higher your tax bill is likely to be.

Landlords often face a meaningful CGT bill when selling, particularly if:

• They purchased many years ago
• Property prices in the region have grown significantly
• They own multiple rental properties

Landlords should be prepared for a potentially large capital gains tax bill and must report gains on their self assessment tax return.

This is why many landlords choose to restructure their financing, release equity, or consider Let-to-Buy arrangements instead of selling immediately.

Capital Gains Tax on Inherited Property

If you inherit a property and later choose to sell it, you may also face CGT. The gain is calculated based on the property’s value at the time you inherited it, not the original owner’s purchase price. Inheritance tax may also apply when you receive property, and this is separate from capital gains tax.

This is important for families planning ahead and can influence decisions about when to sell or whether to hold the property long-term.

Capital Gains Tax on Business Assets

Capital gains tax (CGT) doesn’t just apply to property or personal investments, it’s also a key consideration when selling or disposing of business assets. Business assets can include commercial property, equipment, machinery, shares in a trading company, or even intellectual property used for business purposes. When you sell, transfer, or otherwise dispose of these assets, you may be liable to pay capital gains tax on any profit you make.

The way capital gains tax works for business assets depends on several factors. First, you’ll need to calculate your gain by subtracting the original purchase price and any allowable costs (such as improvement expenses or selling fees) from the sale proceeds. The resulting figure is your chargeable gain, which may be subject to gains tax.

The capital gains tax rate you pay on business assets is influenced by your total taxable income and which income tax band you fall into. Basic rate taxpayers may pay a lower CGT rate, while higher and additional rate taxpayers face a higher tax rate on their gains. The type of business asset and how long you’ve owned it can also affect your tax bill, as certain reliefs or reduced rates may apply for long-term holdings or specific asset types.

It’s important to note that the rules for capital gains tax on business assets can be more complex than for other assets, especially if you’re disposing of shares in a trading company or selling assets as part of winding up a business.

In some cases, special reliefs such as Business Asset Disposal Relief may reduce the amount of tax payable, but eligibility criteria must be met.

If you’re planning to sell business assets, understanding how capital gains tax CGT applies can help you plan ahead, minimise your tax liability, and ensure you’re meeting all your tax obligations. Consulting with a tax adviser is often a wise step to make the most of available reliefs and to avoid unexpected tax bills.

Ways to Reduce Capital Gains Tax on Property

While capital gains tax cannot be avoided completely in most cases, there are perfectly legitimate ways to reduce it. Tax reliefs and CGT relief can help lower your liability by providing exemptions or reductions in the amount of capital gains tax you need to pay.

1. Use your annual exempt amount.
2. Offset allowable losses against gains.
3. Make use of tax-advantaged accounts like ISAs or pensions.
4. Spousal transfers: Transfers to your spouse or civil partner are usually tax-free, allowing you to utilise both individuals’ allowances and potentially reduce your overall tax bill.
5. Donate assets to charity.

If you have more losses than gains in a year, the excess can be carried forward to offset future gains, reducing your capital gains tax liability in subsequent years.

1. Deduct allowable costs

Many people overlook deductions. You can deduct:

• Legal and estate agent fees
• Incidental costs such as broker commissions or surveyor fees
• Stamp duty paid at purchase
• Capital improvements (extensions, conversions, new kitchens, structural work)

2. Use your annual allowance

If you are planning to sell more than one property, selling them in the same tax year may result in higher gains being taxed, as all gains and losses are calculated within the same tax year. Therefore, spacing sales across different tax years can sometimes reduce your CGT exposure.

3. Joint ownership

If two individual investors jointly own and sell a property, each individual investor can use their own CGT allowance, reducing the overall tax.

4. Spousal transfers

You can transfer assets between spouses or civil partners to maximise tax allowances before a sale. Property transfers between spouses or civil partners are usually tax-free, allowing you to transfer assets strategically for tax-planning purposes, such as minimising capital gains tax or taking advantage of reliefs, before a sale.

5. Consider timing the sale

Selling during a lower-income year may reduce your CGT rate if it brings you into a lower income tax rate band, as capital gains tax rates are often linked to income tax rates.

6. Offset gains with losses

If you have other investments that have made a loss, these capital losses can sometimes be used to reduce your CGT on property, and may also be used to offset other capital gains. Additionally, short-term gains on certain assets may be taxed as ordinary income, which is subject to different tax rates than long-term capital gains.

For clients who are unsure how best to plan, I often recommend speaking with a tax adviser alongside mortgage planning.

Capital Gains Tax Example: How It Works in Practice

Let’s imagine you purchased a buy-to-let for £200,000 and later sold it for £300,000. In this example, the property is considered a taxable asset subject to Capital Gains Tax (CGT).

Your gain is £100,000.

From this gain, you may deduct:

• Estate agent fees
• Solicitor fees
• Improvements such as an extension
• Stamp duty paid at the time of purchase

Let’s say these total £10,000.

Your taxable gain becomes £90,000.

From here, your annual CGT allowance reduces the taxable amount further, and whatever remains is charged at the applicable property CGT rate. The remaining gain after allowances and reliefs represents your CGT liability, and paying taxes on time is essential to avoid penalties.

It’s easy to see how CGT quickly becomes a major consideration for landlords and property investors.

Why Capital Gains Tax Matters for Mortgage Planning

As a mortgage broker, I see first-hand how capital gains tax affects decisions such as:

• Whether to sell or remortgage
• Whether to release equity instead of disposing of an asset
• Whether Let-to-Buy is more cost-effective than selling
• How to structure a growing property portfolio
• When to transfer ownership or refinance between partners

CGT isn’t just an accounting exercise. It directly influences the financial strategy behind every property investment decision, especially as changes in cgt rates can significantly affect your overall financial strategy.

Landlords, second-home owners, and anyone considering future property sales can benefit from understanding their potential liability early not after agreeing to a sale. Understanding when and how to pay tax, as well as completing your tax return accurately, is crucial for effective mortgage planning.

Final Thoughts

Capital gains tax on property can be complex, but with the right planning, it can be managed effectively. Whether you’re selling a buy-to-let, disposing of inherited property, or restructuring your portfolio, understanding how CGT works helps you make informed decisions.

As an experienced mortgage broker, I always recommend considering the tax implications before committing to a sale or refinancing strategy. Knowing your exposure could save you thousands and help you build a more efficient long-term property plan.

If you are thinking about selling, refinancing, or adjusting your property portfolio and want guidance on the mortgage side, I would be happy to help you explore your options.

Get help from an experienced mortgage broker.

You can speak to one of our specialist mortgage brokers who would be able to guide you through the process. They will advise if there is a lender available and the maximum loan amount based on your circumstances. We are a whole of market mortgage brokerage with access to all lenders. Call us on 01332 470400 or complete the form with your details for us to give you a call back.

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