The tax implications of selling a house below market value

Sometimes it's in a seller's best interests to sell a property below market value. If you're in need of a quick sale and are thinking about lowering the price of your home, we'll take you through the direct implications of doing so.

What is selling a house below market value?

So, what exactly is selling a house below market value? In simple terms, it means selling a property for less than its estimated worth. This can occur for a variety of reasons, such as when a homeowner is looking to sell to a family member.

You can get a good idea of your home’s estimated worth by booking three valuations with three separate estate agents. Three valuations should be give you a realistic picture of your property's market price. You can compare local agents for free with the GetAgent Online Comparison tool.

Top five reasons for selling a house below market value

Why would anyone sell a house below market price? Turns out there's more than a few reasons:

1. Make a quick sale: For whatever reason, a quick sale is in your best interests and selling your home below market value is an excellent way to speed up the process.
2. Financial problems: You might be in financial straits and require a quick sale to liquidate your assets and quickly pay off your debts.
3. Help a family member: A member of your family may need financial help, whether it's to buy their first home or pay off debts.
4. Bereavement or personal issues: Death, divorce or other personal issues can lead you to the conclusion that a quick sale is the only way forward.
5. Tax benefits: A quick sale can help mitigate the need to pay Capital Gains Tax. We'll touch on this in the next part of the article.

Whatever your reason for selling below market value, it's important to understand the tax implications - which can be significant.

What are the key taxes to be aware of?

There are two main taxes to be aware of if you’re thinking of selling at discount. These are:

• Capital Gains Tax
• Inheritance Tax

Both of these are quite complex taxes - and we go into much broader detail in their respective articles. For now, let’s explore the key implications of selling a house below market in the UK, beginning with Capital Gains.

Capital Gains Tax

You usually have to pay Capital Gains Tax (CGT) when you sell a property and make a profit (the sale price is higher than the original price you purchased the property for). If you sell your property below market value, the CGT calculation will be based on the lower sale price, which may result in a lower tax bill.

Why would you want to benefit from reduced Capital Gains tax?

Capital Gains Tax is a tax on the profit you make from a sale. With CGT scaling in line with the profit you make, you stand to lose more money from a property that has increased in value.

Imagine you've inherited a property from your parents, and you've been renting it out for a number of years. Over time, the property has increased in value, and you've decided that you want to sell it to free up some equity.

But if you sell the property at its current market value, you could potentially incur a significant amount of CGT, as the increase in value since you inherited it would be considered a gain. Naturally, you might want to reduce the amount of tax you owe to maximise your profit.

How can selling below market value help me avoid Capital Gains Tax?

Selling your property below market value won't necessarily help you avoid CGT. In fact, it could have the opposite effect. Selling for less than your property's market value could mean that you're taxed more than you would've been if you had sold at market value.

How does this work? Well, Capital Gains is calculated based on your asset's increase in value since you acquired it (minus expenses). If you sell your property for less than market value, HMRC may consider the sale as ‘a disposal at undervalue’, where the gain is based on the market value - not the sale price. This means that your gain could be higher, and you may end up paying more CGT.

However, there are some situations where selling below market value could help you mitigate increased CGT:

1. Selling to a spouse or civil partner: If you sell to your spouse or civil partner, you'll be able to transfer ownership without incurring CGT. Transfers between spouses or civil partners aren't subject to Capital Gains!
2. Gifting the property to a family member: If you gift your house to a family member, you may be able to avoid or reduce CHT. However, you should be aware that there may be other taxes, like Inheritance Tax, to worry about!
3. Selling to a charity: If you sell to a charity, you may be able to claim relief on the CGT. This is because gifts of land and property to charities are exempt from the tax.

Current Capital Gains Tax rates

The current CGT rate in the UK is 20% for a basic rate taxpayer (income up to £50,000) and 28% for higher rates (income above £50,000). However, there are several exemptions and allowances available that can reduce your Capital Gains Tax bill.

Exemptions and allowances to Capital Gains Tax

• Private Residence Relief: This allows you to exempt any gain made on the sale of your main residence, as long as you have lived there for at least three of the five years before the sale. In some cases, you won't be able to claim this relief, specifically if you're a property developer and you've bought the house to make a gain or part of your home is business premises.
• Annual Exemption: Each tax year, you're entitled to an annual exemption of £12,300. This means that you can make a gain of up to £12,300 each tax year without paying any capital gains tax.

Is it worth selling your property below market value to avoid CGT?

Selling your property below market value might help you avoid some tax, but it could also have the opposite effect. Unless you're selling to a spouse or partner, a charity, or gifting it to a family member, you'd be better-placed considering another option to reduce CGT. Check out some of the other exemptions and allowances to Capital Gains Tax.

How do you pay Capital Gains Tax?

Unlike Stamp Duty Land Tax, paying Capital Gains Tax is your responsibility - not your solicitor's. Luckily, the process is pretty straight-forward.

1. Calculate your Capital Gain: To work out your capital gain, you need to subtract the cost of the property (including any expenses related to the sale, such as legal fees and estate agent fees) from the sale price.
2. Report the sale to HM Revenue and Customs (HMRC): You must report the sale and pay any tax due within 30 days of the sale completing. To do this, you need to register for the HMRC online service and use the online Capital Gains Tax service.
3. Fill out the Capital Gains Tax form: You need to fill out the Capital Gains Tax form (form CGT30) and send it to HMRC, along with your payment. This form details your calculations and any reliefs or exemptions you're claiming.
4. Pay it: The amount of tax you pay depends on your income and the size of your capital gain. The current tax rates for CGT on property sales in the UK are 18% for basic rate taxpayers and 28% for higher rate taxpayers.
5. Keep records: Keep records of the sale and all the costs associated with it, as you'll need them when you fill out your tax return.

Inheritance Tax

Inheritance Tax is a tax on the total value of your estate when you die. This includes all of your possessions, property, money and investments. It's not always applicable - if you're single, you won't need to pay Inheritance Tax on estates worth less than £325,000, or worth more than £650,000 if you're married.

If you sell your house below market value, it can have direct implications for Inheritance Tax. Let's take a look at how this works.

Selling below market value and Inheritance Tax

If you sell your property to a family member or friend at a price below its estimated value, HMRC may consider the difference between the sale price and the market value a 'gift'. Effectively, you've given away some of the value of the property to your family member or friend and HMRC may see this as an attempt to reduce your estate's value for Inheritance Tax.

So If HMRC considers the difference to be a gift, it may be subject to Inheritance Tax if you die within seven years of the sale. This is because the gift will be considered a potentially exempt transfer, and Inheritance Tax will be due if the total value of your estate exceeds the nil-rate band at the time of your death.

The Seven year rule

When you give away an asset, including property as a gift, Inheritance Tax rules may apply if the gift was made within seven years of your death. This is known as the Seven Year Rule.

Inheritance Tax Rates

If your estate comprises more than £325,000, your estate will need to pay IHT. This is at a rate of 40% on estates worth more than £325,000 or £650,000 for married couples or civil partners who leave everything to each other.

If the value of estate is below this threshold, there is no IHT to pay. But if the value of estate is above the thresholds then tax is paid on the amount above.

There are exemptions and reliefs that can reduce IHT due, such as gifts made to individuals during the deceased person's lifetime - and certain types of assets like properties which are left to spouses, civil partners or children.

Exemptions and allowances to Inheritance Tax

• Nil-rate band: Every individual has a tax-free allowance of up to £325,000. This is called the 'nil-rate band', and what it means is that no Inheritance Tax is payable on the first £325,000 of an individual's estate upon death.
• Residence nil-rate band: There's also a 'residence nil-rate band (RNRB)' available for individuals who leave their main residence to their direct descendants (children or grandchildren). The RNRB is currently £175,000 per married person and is set to increase each year in line with inflation.
• Spousal exemption: If you leave any assets to your surviving spouse or civil partner, they'll be exempt from Inheritance Tax - regardless of value.
• Charity exemption: Assets left to a UK registered charity are exempt from Inheritance Tax.
• Annual exemption: You're entitled to give away up to £3,000 per year without incurring Inheritance Tax.
• Small Gifts exemption: You can also give small gifts up to £250 per person per year without paying any Inheritance Tax.

Is it worth selling your property below market value to avoid Inheritance Tax?

If you have an estate that's valued over the Inheritance Tax nil bands, it might be worth selling your property to your children at a cheaper market rate - but you'd have to consider the morbid seven year rule. If you die before the end of the seven year period, your beneficiaries will have to pay the difference between the sold price and market value.

In addition, if you sell your property below market value and continue to live in it, you may also trigger other tax implications like Capital Gains. For more information, check out our blog 'How to avoid Inheritance Tax on property'.

Gift Aid

If you sell your house below market value to a charitable organisation, and the sale price is less than the market value, you may be able to claim Gift Aid on the difference between the market value and the purchase price. Gift Aid lets you increase the value of a charitable donation by 25% at no extra cost.

Gift aid specifications

There are strict rules around Gift Aid, and you must be a UK taxpayer to claim it. You'll also need to provide the charity with a declaration that confirms you're a UK taxpayer and that you want the charity to treat the donation as a Gift Aid donation.

Other implications for selling below market value

There are other implications to be aware of if you’re thinking of selling your home below market value. For example, if you're thinking of selling to family members or friends, you may end up experiencing some push back from mortgage lenders. A mortgage lender might be hesitant to lend against a property where the parties in the chain are related.

There’s potential for more serious consequences too. If the sale is to a family member or friend, and they subsequently become bankrupt, creditors may be able to challenge the sale as a fraudulent transfer.

As such, it’s best to carefully consider your options before you decide to sell your property at a significant discount.

Summary: Not something you should rush into

Whether you're looking to reduce your Capital Gains or Inheritance Tax, or claim Gift Aid, it's important to understand the implications of selling a property below market value, especially where your pocket is concerned.

If you're still unsure about the consequences of selling your home for a low price, it might be worth enlisting the help of a financial advisor. Advisors are experienced specialists who can help you calculate and reduce your liability for taxation in these circumstances.