Inflationary gains and the CGT trap
The current capital gains tax (CGT) rules don't give you any breaks for inflationary gains. This means if you've owned an investment property or second home for a long time and decide to sell, you might end up paying a hefty amount in CGT. The rules treat the entire gain from the time you bought it to when you sell it as if it all happened in the year you sell. So, only the current year's tax-free allowance applies to the gain. This can be a big problem if you've taken equity out of the property to put deposits on other investments.
Example
Lucy bought a two-bedroom property in 2004 for £120,000. By 2024, it's worth £280,000. She's re-mortgaged the property several times to get deposits for more properties and now has a £250,000 mortgage on it. With rising interest rates, Lucy wants to sell the property.
The incidental costs of selling and buying are £10,000. The gain on selling the property is £150,000 (£280,000 - £120,000 - £10,000). Lucy hasn't used her £6,000 annual exempt amount (2023/24 rate), which cuts the chargeable gain to £144,000.
Since Lucy is a higher rate taxpayer, she needs to pay £40,320 in CGT (£144,000 @ 28%) within 60 days of the sale. The sale proceeds aren't enough to cover the tax and clear the mortgage.
If Lucy had invested in shares and sold enough each year to use her annual exempt amount, she could have realized a significant tax-free gain over the same 20-year period.
When Lucy bought the property, she got a two-bedroom place at the market rate. But selling it many years later and paying CGT on the whole gain means she wouldn't have enough to buy a similar property if she wanted to reinvest. CGT is owed even if the property's value only went up with inflation, and the longer you hold the property, the bigger this problem gets.
The situation is worse because CGT, introduced in 1965, hasn't been rebased since 1982.
Think Ahead
If you're considering property as a long-term investment, like for retirement funds, keep the inflationary gains trap in mind. Paying CGT on big inflationary gains for a property held for many years will seriously cut into the funds you'll have when you sell it.