How to build a property portfolio and avoid capital gains tax
When investors are considering how to build an investment property portfolio, remortgaging is a proven strategy to build your investment wealth. It’s also a great way to avoid capital gains tax when you’re adding to a property portfolio. In fact, a remortgaging strategy can reduce your liability to all three main taxes:
- Capital gains tax
- Income tax
- Inheritance tax
In this investment blog, we’ll walk you through an example to show you how remortgaging helps you to crush capital gains tax when you’re building a property portfolio. You’ll also discover why it’s important to take advice when remortgaging.
Sell or remortgage? The choice is yours
A few years ago, one of our clients, Barry, wanted to build a residential investment property portfolio. At the time, he owned a single buy-to-let investment property in the Midlands. He’d bought it for £30,000 in 1999, and it had been valued at £80,000.
Barry thought that property values in the Midlands were going to stagnate, and wanted to invest further north, in Manchester. He’d considered selling his investment property but had been horrified to learn he’d have to pay £20,000 in capital gains tax. After he’d repaid his mortgage, he’d be left with only £30,000 to invest.
We introduced him to remortgaging. He was surprised to hear that he could:
- Keep his property in the Midlands
- Continue to benefit from the positive cash flow from his property
- Pay no capital gains tax
- Buy an investment property in Manchester
He didn’t have to pay £20,000 to the taxman. He remortgaged to 75% of the property value and released £30,000. He kept the rental income from his Midlands property. With the £30,000 as a deposit, he could get a buy-to-let mortgage to finance his property investment in Manchester.
The capital gains tax advantage of remortgaging
Barry now owned two properties. His small portfolio was valued at £170,000. His mortgages totalled £120,000.
Because capital gains tax is charged when you sell or dispose of an investment property, Barry had avoided any CGT liability at this stage. By remortgaging, Barry had released some of the capital gains without a tax bill.
This capital gains tax advantage of remortgaging exists whatever the reason for remortgaging. Whether you remortgage to help build a property portfolio or to pay for your daughter’s wedding, you won’t have to pay capital gains tax. You could boost your financial position without a tax liability.
You can’t avoid capital gains tax forever
Okay before you get carried away, remortgaging doesn’t remove your capital gains tax liability altogether. Rather, it’s deferred. If and when you eventually sell your investment property, to calculate the gain you deduct the original cost from the sale price.
Barry still owns the Midlands property. It’s now valued at around £150,000. He’s remortgaged again since that first remortgage, to help him expand his property portfolio. The total amount of his mortgage against it is £100,000. So, if he were to sell today, he would:
- Make a real capital gain of £120,000 (£150,000 – £30,000)
- Pay off his mortgage of £100,000
- Have £50,000 profit before capital gains tax
Your capital gains tax liability is calculated on the real capital gain. In Barry’s case, this is £120,000. As a higher rate taxpayer, Barry will have to pay 28% of £120,000 (£33,600).
So, although Barry’s investment property has increased fivefold, the amount he can bank is reduced because of his remortgaging strategy. If he’d remortgaged more aggressively, Barry might have found himself owing the taxman more than he realised from his sale.
The moral is this: remortgaging is a great way to release equity, realise profits, and avoid capital gains tax. It can help a property investor build a property portfolio much faster. But only if you remortgage sensibly.
Always remember that if you do need to sell a property, the actual amount of cash you put in your pocket will be affected by the amount of your remortgages. The taxman, however, won’t allow you to offset remortgages that release equity against your capital gains tax bill. Instead of crushing capital gains tax, it could crush you.
How do you remortgage safely?
When Barry first spoke to us, he wasn’t sure how he could afford a property investment in Manchester. We showed him how he could invest in Manchester, and keep his Midlands property and the positive cash flow it produces.
By working out a safe remortgage amount, we also made sure that Barry will be in a position to be able to afford to sell his property if he needs to.
If you remortgage too aggressively, you could find yourself unable to sell. Before you remortgage, contact one of our team today on +44 (0)207 923 6100. We’ll show you how to remortgage to build your property portfolio and to stay in the black with capital gains tax.
In our next investment blog post, I’ll explain how remortgaging also helped Barry reduce his income tax bill.
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