Downsizing could be the right decision for your changing lifestyle, but there are tax implications to consider. We take a look...

If you’re planning to downsize, you’ll need to factor in the tax you’ll end up paying in the process. Hargreaves Lansdown’s personal finance analyst, Sarah Coles, helps Zoopla answer the important questions.

1. How much tax will I pay if I downsize?

The good news is that there’s usually no tax on the sale. You won’t usually pay capital gains tax (CGT) as long as it has been your only property (or your main one) for the whole period you owned it.

There are some instances when at least some CGT is due, such as if you have more than one lodger, you let the whole property out for any length of time, or you have more than half a hectare of land.

However, in the vast majority of cases, when you downsize, the only tax to consider is stamp duty on your new purchase.

The size of your stamp duty bill will depend on the value of the property you’re buying. You pay the applicable rate of tax on each portion of the property:

£125,000 tax-free
£125,001 - £250,000   2%
£250,001 - £925,000   5%
£925,001 - £1,500,000 10%
£1,500,000+ 12%

The stamp duty rules are the same regardless of whether you are buying a normal family home or a specific retirement property.

2. What if I want to have an overlap period when I own both properties?

This is a relatively common approach, especially when people want to adapt their new home, or take their time in decluttering. Unfortunately, you’ll need to factor in a higher tax bill over the short term.

The issue you come up against is that there’s a higher stamp duty charge on second properties, so if you haven’t sold your main property yet, there will be a 3% stamp duty surcharge.

This extra tax will be refunded as long as you sell your old home within 36 months, but in the interim you’ll have to factor it in.

If you can do as much as possible before the move and avoid the overlap, it’ll be one less thing to worry about.

We’ve got golden rules for decluttering which could help with the transition.

3. Given the stamp duty tax charge, is it cheaper to use equity release?

This depends on the value of the property you downsize to, or how much equity you release, plus how much longer you live. For most people, it’s far cheaper to pay the stamp duty.

If, for example, you had a £400,000 property and downsized to a £250,000 property, it would cost £2,500 in stamp duty. If you freed up the same amount through equity release at 3.5%, the rolled up interest would exceed £5,000 in the first year alone.

Even after you factor in all the costs of moving, you’d probably be better off downsizing.

4. What about inheritance tax?

Everyone has an inheritance tax-free allowance of £325,000, so anything you leave up to this amount is tax-free. 

Since April 2017, as long as you’re passing your property to children or grandchildren, you also get a residence nil rate band, so you can pass a chunk of your home on tax-free. In the current tax year it’s £150,000 and it rises to £175,000 in April 2020.

Anything you pass to a civil partner or spouse is free of inheritance tax. At the same time, you also pass your inheritance tax allowance to them. It means the surviving spouse has an allowance of £650,000, plus £300,000 of property.

The question for downsizers is what happens if they downsize to a property worth less than the residence nil rate band? Will they waste it?

The good news is that downsizing was built into the new rules. If you downsized after July 8, 2015, you can leave the new smaller property to your children or grandchildren, plus assets equivalent to the lost residence nil rate band, and the whole lot can be left inheritance tax-free.

It’s important to remember that tax rules can change, and the benefits depend on your individual circumstances.

If you’re thinking of selling your home, find the best estate agents in your local area with Zoopla's AgentFinder tool.

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