Will old family home cost us tax if we hold on to it?

Q&A: Dominic Coyle

 

Question: We have built a new home. We would love to keep our current house (which we have lived in for 25 years ):

a) as part of our pension plan;

b) to be used if necessary by our children.

I understood that if the house is now valued at €300,000 and rises to €350,000 over next five years, we would only pay CGT on the €50,000 increase in value after it ceased to be our principal private residence.

However, I have been told it is a sliding increase in CGT every year. Thus you can lose the benefit of CGT exemption on a family home in a short enough time period.

Which one is correct? I’ve been looking online but cannot really find relevant information.

Ms F.O’C., email

Answer: Neither scenario is correct? In fact, I’m not entirely certain what the second one is about. It seems to be suggesting that, at some point, you would lose any credit for the property being your family home for 25 years. That’s certainly not the case.

But, while your original understanding might be nice and clear-cut, the reality is not that neat either.

Still, when it comes to capital gains, the position is fairly straightforward. You buy an asset at price A and you sell it at price B. The capital gain is B – A.

Where things get complicated is when you get into the whole area of exemptions and indexation.

Let’s take your case. You bought this home back in 1992 or 1993 and you are now moving into your new home. Until now, you qualify for the single most important exemption to capital gains – principal private residence relief. Essentially, your family home is free from capital gains tax, regardless of its current value. If you sold the property now, there would be no tax bill and no complications.

The complication for you going forward is that this will no longer be your family home but you will continue to own it – for whatever reason. Once you move into your new home, which will be free from CGT as your principal private residence, this former home becomes an investment property and capital gains looms as an issue.

Quite how much tax you would pay ultimately depends on when you eventually sell the property. Essentially you need to work out what proportion of ownership was as a family home as how much as an investment . . . and you pay CGT on the investment portion.

Let’s say, you hold on to the property until October 2030. Having bought it in late 1992 – you don’t give a precise date but let’s say October 1992 – you will have owned it for 38 years or, more precisely, 456 months. The months are important because that is what Revenue uses in is calculations.

For 25 years – or 302 months up to December 2017 – it was a principal private residence: for the balance – 154 months – it is an investment.

However, as it was once a family home, the final 12 months of ownership is considered to be owner occupation, regardless of the reality. So that means 314 months of family ownership discounted for capital gains tax and 142 months as an investment subject to capital gains.

Of course, to work out the tax you need to know what you first paid for the house and what you eventually sell it for.

Let’s say you paid the punt equivalent of €100,000 back in 1992 and it is worth €700,000 in October 2030. That’s a gap – or gain – of €600,000. But you can narrow that a bit.

First, back in 1992, there was a multiplier in place to adjust purchase prices to allow for inflation. This was seen as essential to ensure only a real money gain was taxed.

The indexation multiple was discarded by then finance minister Charlie McCreevy at the end of 2002. For anyone buying property or other assets since then it is irrelevant. However, for you, assuming you bought this home between April 6th, 1992 and April 5th, 1993, you multiply the purchase price by a multiplier – in this case, 1.356 – to give you a new “purchase price” of €135,600.

For your own information, if the purchase was made in the same period in 1993/94 – we had that funny British tax year back then – the relevant multiplier would be 1.331.

Back to 1992, your gain is now €564,400. You can also deduct costs incurred in buying and selling the property which, naturally, would eat into your gain – especially when you consider the impact of stamp duty back then.

Let’s say the selling costs are around €10,000 and the purchase costs were €15,000. That’s another €25,000 off the gain, bringing it down to €539,000.

If you built an extension or other “capital improvement”, that too is deducted – let’s say another €20,000. The gain is now €519,000.

Fair enough, but how do we split that between the time it was a family home and the future period when it is going to be an “investment” – even if it is not rented out? Pro rata is the answer.

In our example, the full period of ownership is 456 months, of which 142 are the period in which it is subject to capital gains. So you multiply the headline net gain of €519,000 by 142 and divide that figure by 456 – ie 519,000 * 142 = 73,698,000 / 456 = 161,618.

So from your original net gain of €519,000, your taxable gain is just €161,618. You then deduct the annual capital gains tax exemption to which everyone is entitled – €1,270 – leaving you a net taxable gain of €160,348.

We obviously don’t know what the capital gains tax rate will be in 2030 but, assuming it is still the current rate of 33 per cent, your capital gains tax bill would be €52,915.

As you can see, there are a lot of variables here and any final bill you face will depend on the price you originally paid for the property, the ancillary costs involved back then, when you sell and at what price, and any costs you incur at that stage.

But the bottom line is that you look at the gain over the full period of ownership but you do get credit against capital gains for the 25 years during which the house was your family home, and also for the final 12 months of ownership.

Of course, if you do rent out the property as part of your pension planning, that will bring additional taxation issues on rental income into the equation. And if you allow your independent adult children live there free of charge, that too could have implications. But that’s a matter for a different day.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or by email to dcoyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice

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