Capital Gains Tax (CGT) is one of the least understood, but most onerous of personal taxes. Those who make capital gains or inherit wealth may be liable for CGT or its sister levy, Capital Acquisitions Tax (CAT), payable on receipt of a cash gift or inheritance.
Ms M from Dublin is on the verge of a CGT headache if she goes ahead and sells her house, which she bought 10 years ago in a Dublin inner-city neighbourhood.
"I bought this large rambling house, with a pre-1963 separate flat on the top floor 10 years ago when property prices were low. I rented out the flat to help pay the mortgage, did the honest thing and declared the income and registered as a landlord. Now, as I think of selling, like everywhere in Dublin, prices have rocketed and the cold reality of CGT looms."
The problem for our reader is that because a third of her house had been rented out, she is liable to CGT, payable at 40 per cent, on a third of the proceeds of the property sale. But CGT relief, which applies if you hold an asset for at least a year, is indexed in line with the Consumer Price Index (CPI) and not, in this case, in line with property inflation.
The CPI has risen by roughly by 30 per cent, while house inflation has risen by 300 per cent. The indexation relief has simply not kept in line and her CGT bill will be disproportionately high - perhaps as much as £20,000.
"It's not as if I haven't already paid tax on the small rental income," she writes. "I now probably can't afford to sell, added to which it now costs me to keep renting the flat since the rental income doesn't cover the extra CGT payment which I will end up having to pay because house prices are still rising so fast.
"Apart from charging exorbitant rent, or letting the top of the house stand idle, or moving into the black economy and not paying income tax on the rent, have you any advice?"
Ms M has outlined her dilemma very well. But the tax adviser we consulted, Mr Sebastian Devlin of the Taxation Advice Bureau doesn't have any good news: "I'm afraid your reader is stuck with this CGT bill. Even if she stopped renting out her flat for, say, two years and then sold the house, she would still be required to pay the CGT on 10/12ths - 10 of the 12 years she owned the house and rented out the flat - on the taxable portion of the profits from the sale. She should make sure she has included all her expenses and running costs in her calculations as these are CGT deductible."
By using the house solely as her principle residence for two years, there is also a chance that it will increase in value enough over that period to help offset the cost of the CGT for the previous decade.
But Mr Devlin says that she would have to make a special case to the Revenue to have the CGT valuation made to 1997 and not to 1999. Our reader is advised to consult an accountant to work out the details.
Even though a CGT bill for a realised asset like a house may seem steep, it is still offset by the fact that substantial profits are being made due to the property boom.
For example, a house purchased entirely for investment purposes 10 years ago for say, £30,000, and selling today for £130,000 represents a paper gain of £100,000 in addition to rental income, which, let us assume was £3,000 per annum. (Despite income tax which would have averaged out at about 50 per cent over the period the owners could have earned at least £2,000 a year after their running costs were deducted.)
If we also assume that £20,000 was spent on the maintenance and decoration of the property in 1990 by the owners, a married couple, their total CGT bill, if they sold the property this year, would amount to about £26,000. The clear profit they have earned on the sale is £64,500 after their renovations and actual sale costs of £1,500 are taken into account. Their income over the decade would have amounted to £20,000. In all, their £30,000 investment has paid off handsomely with total cumulative profits of about £85,000.
