Wednesday, 9 July 2008

The penny has finally dropped...

I was advising a client* a few months ago about the likely capital gains tax bill, were he and his wife to sell a house which was standing at a capital gain of £1 million**. They bought it in 1991 and lived there until 1997, when they bought a new flat in London (for job related reasons). Since then they have lived in the new flat and rented out their old home. They intend to sell the London flat (also standing at a huge capital gain) when they take early retirement in 2010 and can't decide whether to move back into their old home, or sell it and trade down.

Well, say I, the capital gain on the new flat is nothing to worry about as you lived there throughout the period of ownership - you get the so-called 'private residence exemption'. Simple enough.

And, as to your old home, if you move back in in 2010 and then decide you don't like it and sell it a year later, the gain of £1 million is divided into twenty years of ownership. The first six are exempt because you actually lived there, the last three are exempt because you lived there at some time in the period of ownership, another four years' because the law says so and then another three years because you moved away for work reasons - but the last two chunks are only exempt if you move back in for a year (Motley Fool so a nice summary of this, or you can refer to the proper legislation).

Great, so sixteen-twentieths of the gain are exempt. That leaves us with a potentially taxable gain of £200,000. Split that 50/50 between husband and wife makes £100,000 each. Knock off the £40,000 letting exemption and the Annual Exempt Amount of £9,600 leaves you with £50,400 each taxable at 18%, gives a tax bill of about £9,000 each.

"Wow, that's great," says the client, "£18,000 tax on a £1 million gain! Why are the rules so generous?"

I didn't actually have an answer to that ... until the whole story about MPs and their taxpayer-funded second homes came to light.

So now we know. MPs don't just help themselves to our money to buy themselves second homes, they have bent and shaped the capital gains tax legislation to make damn' sure that they pay precious little tax either.

* I have simplified this a bit to illustrate the point.

** A bit less now, I think, but at the time the client refused to countenance the possibility that prices would tank.


Anonymous said...

MW, unless your post was jocular (in which case apologies for responding too seriously) I think you credit MPs with too much intelligence and foresight. Basically they're just greedy scrotes who, in a large number of cases, will walk away from their "careers" with substantial assets bought at the expense of the rest of us.

Certainly their CGT bill will be limited by the existing legislation but I consider it's beyond the intellectual power of the (largely) innumerate 646 parasites to have deliberately twisted the law in their favour in this particular instance. Up to now it has not been necessary to be subtle (and this CGT ramp would be subtle) to benefit from the parliamentary gravy train. After all, our representatives have been able to indulge their straightforward unapologetic cupidity without much scrutiny, let alone criticism,from the punters.

Anonymous said...

Would it not have been better to have advised them to burn their first house down and claim the insurance money, or would the insurance payout have been equally subject to CGT?

Mark Wadsworth said...

U, I am being quite serious. There are a couple of other exemptions in the Taxes Act that, in practice, only apply to cabinet ministers.

And, because MPs nearly all have second homes, perhaps that is why they were so keen to see prices rise as sharply as they did, and are now panicking because they are losing twice as much money as everybody else (serve 'em right!).

JE, insurance proceeds are disposal proceeds just as if you sold the property.

Anonymous said...

"There are a couple of other exemptions . . . . "

I must admit I never knew. What I would repeat though is that I doubt that many of the parasites have the nous to twist the general tax law deliberately in their favour since what they have got away with legitimately (well legally anyway) over the years would make a whore vomit.

OTOH they have civil servants writing the legislation for them so a bit of legal corruption cannot be ruled out. These are the same snouts in trough whose ploy in connecting civil service pay rates to MPs pay (thus at one stroke emasculating any parliamentary control over civil service pay) was so brilliantly exposed in "Yes Minister".

Andrew Brooks said...

The rules are only seen as generous if you have a flying housing market. Back in the day, when the rules were introduced, the property market was very different in nature. The average or even the rich punter benefited from the rules, but not to any great extent, because spectacular housing gains were not to be had to the degree they have been since the late 1990s.

The "3 year" rule was enacted not as a perk for anyone but as a relieving measure and, in the context of the times, probably sensibly so because it was designed to stop those who, for job moves or whatever, ended up with two proeprties for a relatively short space of time and would otherwise find themselves dragged into a tax system for relatively small money and in circumstances where parliament did not see this as desirable or worthwhile.

This "3 years" of deemed residence following a period of actual residence was originally only 2 years. The extension to 3 years was made in the height of the early 1990s recession when the property market was deader than Elvis and it could then take close to three years to sell a property. The extension was only meant, at its time of introduction, to be temporaray and it was, again, in the nature of a relieving measure. The return to 2 years can still be done at any time merely by Treasury Order.

The rules in question apply equally to all, whether MPs or not. Whilst many advisers and our clients have had cause to wonder over the past decade as to why the rules (with their consequential generosity of result brought about by the housing bubble) are so benign, perhaps we should now be asking whether the MPs (better able than many to take advantage, because of their public subsidy) have had an overriding personal vested interest in leaving the laws unchanged.

The issue here seems not to be the doubling or trebling up by MPs on what are, in essence, tax free properties, because they have been doing nothing unlawful (always assuming there has been actual residence in the properties). And a considerable number of non MPs have benefitted as well ove rth epast decade. Rather, I feel the real question is whether the MPs have been acting in the best interest of the electorate, or just themeslves, in creating and presiding over a housing bubble and all that comes with it.

Good for them, as recent revelations have shown, but that's not the same as being good for the country as a whole. Add these latest exposes to the questions already being asked over the "management" of the housing market, the lack of regulation over mortgage lending, why an obviously unsustainable market was left unchecked etc., etc., and there is serious cause for concern, imho.