In this post we will look at “Reinvestment Relief”. Numerous questions are asked about this relief and we will try to get to grips with the most common scenarios when this relief may be considered.
Property Investors and Reinvestment Relief
Property investors often ask if they can defer paying CGT on gains they have made by reinvesting the money in another property.
Unfortunately, this is generally not possible.
There are only two exceptions:
A company (or an individual or partnership) which is carrying on a trade can claim “rollover relief” from tax on its capital gains if it sells an asset it has used for its trade and spends all the sale proceeds on buying another asset to use in its trade. Those sale proceeds do not need to be “ring fenced” or identified separately and it is sufficient merely to apply an equivalent amount of funds to make a qualifying purchase within the relevant time limits
The new asset must be purchased within the period that begins one year before the old asset is sold, and ends three years after that sale.
There are several categories of asset that qualify for this relief, and among them are land and buildings that are occupied and used for the purposes of the trade being carried on.
This type of rollover relief is unlikely to be of much use to the property business. It will not apply to the buy to let investor, because he is not carrying on a trade, and it will not apply to the buildings sold by a property developer, because these buildings are his trading stock and he makes a profit chargeable to Income Tax when he sells them, not a capital gain. But it could apply to his business premises, or other assets used in the trade.
Furnished Holiday Lettings
These are a special category of buy to let property and rollover relief is available if one of these specially eligible properties is sold and the proceeds used to buy another eligible property.
Case Study: Furnished Holiday Lettings and Reinvestment Relief
Chris owns a cottage which he lets according to the rules for “furnished holiday accommodation”. The cottage cost him £50,000 six years ago, and he sells it for £200,000.
The gain of £150,000 will usually qualify for ER/BADR because this type of letting is deemed to be a trade for certain tax purposes, so he has a taxable gain of £150,000, on which he would pay £15,000 given the 10% tax rate (assuming his CGT Annual Exemption has already been used).
Chris spends £220,000 on another qualifying holiday cottage one year after the sale of the old one. He has effectively used the entire amount of the sale proceeds from the old cottage to buy the new one, so all of the capital gain on the old cottage may instead be “rolled over” into the new one, and Chris makes a claim for Reinvestment Relief instead of Entrepreneurs’ Relief / Business Asset Disposal Relief. When Chris comes to sell the new cottage, its cost for the purposes of CGT will be reduced by the amount of the gain that has been rolled over into it:
|Amount spent on new cottage||220,000|
|Deduct capital gain rolled over from old cottage||(150,000)|
|Cost of new cottage for CGT purposes||70,000|
There is some relief even if you do not reinvest all of the sale proceeds. Suppose that the new cottage costs Chris only £180,000. This is less than the sale proceeds of the old cottage, so the computation goes like this:
First, find the amount of the sale proceeds not reinvested. Here, this is £20,000 (£200,000 – £180,000). This is less than the capital gain of £150,000 on the old cottage, so the amount of the gain that has not been reinvested is £20,000.
Chris will remain taxable on a gain of £20,000, (again potentially subject to Entrepreneurs’ Relief/Business Asset Disposal Relief) and the cost for CGT purposes of the new cottage, for when it comes to be sold, will be:
|Amount spent on new cottage||180,000|
|Deduct capital gain rolled over from old cottage||(130,000)|
|Cost of new cottage for CGT purposes||50,000|
There is one other point to bear in mind about furnished holiday accommodation.
Because it would be possible for a person to roll a gain on an old holiday cottage over into a new one, and then move into it as his or her main residence and so “exempt” the entire gain from CGT on that cottage’s later disposal, the relief is only given provisionally and if, when the new property is sold, it qualifies for relief from CGT as a main residence, the gain previously held over is brought back into charge.
There is another way to defer a capital gain by reinvesting into specially qualifying companies, rather than into property itself. This is by using the Enterprise Investment Scheme (“EIS”) for individuals. This is a scheme that offers tax advantages for investment in the appropriate sort of company.
Deferring Capital Gains by Reinvesting
Enterprise Investment Scheme (EIS)
The EIS offers three forms of tax relief to an individual who invests in new shares – a subscription – in an EIS company:
- Income Tax relief (currently at 30%) on the amount (generally up to £1,000,000 but the limit has increased to £2million for “knowledge-intensive company” share investments from 6 April 2018) invested in EIS qualifying shares, provided that the individual is not “connected” with the company – that is, he and his “associates” do not own or control more than 30% of it.
- If the shares qualify for the above Income Tax relief, and they are later sold at a loss, that loss can be deducted from the investor’s income for the year.
- If the shares qualify for the Income Tax relief, and are sold at a profit after more than three years, the profit is exempt from CGT, except for any gains “deferred” – see next bullet point.
- Deferral of other capital gains on any amount reinvested in EIS shares – this relief applies whether or not the individual is “connected” to the EIS company, and is the one we shall concentrate on here.
The investment must be made within the same time limit as for rollover relief – one year before to three years after the gain to be deferred.
An EIS company must meet certain conditions if it is to be a “qualifying company” and its shareholders can get tax relief on their investment.
The detailed rules are very complicated, and expert tax advice is essential if you are contemplating an EIS investment, but in outline:
- The company must not be listed on a Stock Market.
- It must not be controlled by another company.
- It must carry on a “qualifying trade” and have a “permanent establishment” in the UK.
A qualifying trade is defined by excluding certain types of trade – any other trade will be a “qualifying trade”.
The following are “excluded activities” and a company which carries on any of these trades will not be a “qualifying company” for EIS purposes:
- Dealing in land, commodities, shares or other financial instruments.
- Dealing in goods (except for ordinary wholesalers and retailers).
- Banking, insurance, money-lending, and other financial activities.
- Leasing or receiving royalties or licence fees.
- Providing legal or accountancy services.
- Property development (before you get any ideas..!).
- Farming or market gardening.
- Woodlands or forestry activities.
- Producing coal or steel.
- Running hotels or similar establishments.
- Running nursing homes or residential care homes.
- Subsidised electricity generation.
The EIS company must carry on its qualifying trade for at least three years from the date it issues the EIS shares on which tax relief is claimed.
The list of “excluded activities” means that a property company could never be an EIS company, but an EIS company investment may nevertheless be of interest to a property investor who has already made a large capital gain by selling one or more of his properties.
Case Study: EIS Deferral Relief
Gary has just sold his property portfolio for £2 million, and has made a gain of £500,000.
He decides to set up an eligible trading company. His Tax Adviser explains that it should be possible to set the company up in such a way that he will qualify for EIS deferral relief.
Gary pays his new company £500,000 and the company issues shares to him in return. Because Gary owns more than 30% of the company (in fact, he owns it all!) he cannot claim the EIS Income Tax relief on his subscription for the shares, but he can still claim deferral relief for his capital gain.
As Gary has invested the full amount of the gain in the EIS company, all of his capital gain is deferred – note that for the EIS it is not necessary to invest all the sale proceeds, (unlike with rollover relief), but just the gain itself.
The company spends the £500,000 on setting up a trade (it must do this within strict time limits). Provided it continues to run the trade for at least three years, Gary’s deferral relief is safe.
When Gary sells the shares, the £500,000 gain he deferred becomes taxable again – though he could defer the gain once more by investing in another EIS company.
Any gain on the shares themselves will not be exempt (because he did not qualify for the Income Tax relief as he owned over 30% of the company), but this too could be deferred by another EIS investment. Do you plan to reinvest profits from the sale of a property? Find out here how reinvestment relief can save you money when reinvesting.
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