Capital gains tax can take a considerable chunk out of property investors’ profits. But with a straightforward strategy, you can entirely avoid its effects.
The Capital Gains Trap
Capital gains tax kicks in when you sell anything that’s gained value since you bought it.
This applies to any property other than your own home. Depending on the property and your circumstances, it can range from 10% to 28% of your profit.
This is going to affect any property investor. The more serious you are about making money off those investments, the more you’re going to be affected.
After all, to make a good profit on property, it’s not enough just to buy one or two places and let the money trickle in. You want to make the most of their rising value, extracting that wealth to buy more property and expand your empire.
The obvious way to do this is to sell off the property once it reaches a value that you like. But if you’re doing that regularly and paying capital gains every time, then you’re going to lose a lot of your earnings.
Fortunately, there’s a simple way to reduce capital gains tax.
While selling a property is the most obvious way to get at its value, there is another option – re-mortgaging.
You can use the value of your existing property to buy new places without selling the old one.
Once you’ve paid off the mortgage used to acquire a new place, re-mortgage and use the money to buy somewhere new.
As long as you’ve got tenants in the old property, you won’t need to worry about finding the money to pay that mortgage back, so it can all go into growth.
Because you’re not selling any property, you won’t be eligible for capital gains tax. So you reduce capital gains tax.
You can keep expanding your portfolio without giving up any of your profits. And the more property you have, the more options you have for re-mortgaging in future and so expanding your wealth.
The Risks and Challenges
The most significant risk with this strategy is the same as with any property investment – what if you can’t find tenants?
Then you’re stuck repaying the mortgage from your pocket and may struggle to make those payments.
Ironically, taking on more mortgages for more property can help to protect you from this risk. The more properties you own, the less of your eggs are in a single basket.
If one property lies vacant for a while, then that’s less of a problem if it’s one out of a dozen rather than one out of two. You can use profits from the others to cover the costs.
One challenge might be convincing lenders to give you a mortgage.
What if the bank is playing safe and you can’t get the mortgage, or you don’t have a deposit to go with it?
This was a big problem a decade ago, following the financial crash. Banks pulled back from mortgages of 80-85% loan to value of a property, tightening all our belts.
But things have improved since then. In the right circumstances, you can get a 75% loan to value, and the market is improving.
If you get stuck, then it may be worth seeking out private finance.
Local property investor meetups can be a great source of funds as long as you’re careful about who you’re borrowing the money from and make sure that there’s a well-written contract around it.
Use this to buy the property, make improvements, get tenants in, and then use the improved value to obtain a re-mortgage and pay the investor back. All while avoiding capital gains.
A Path to Growth
Re-mortgaging isn’t just the easiest way to avoid capital gains tax. It’s also a way of maximising your financial growth.
Because you’re not selling one property to buy the next, your portfolio keeps growing. And you reduce capital gains tax.
As long as you manage the properties properly, you should be able to keep them tenanted, covering those mortgage costs and adding to your income while you accumulate value in those properties.
In the end, there will be taxes. When you pass away, your properties will be subject to inheritance tax. But that would be true however you’d acquired them.
It’s just that this way this won’t be salt in the capital gains wound.
With higher growth and lower taxes, re-mortgaging increases your property profits both coming and going. If you can do it, then it’s hard to see a reason not to.