Should I sell my rental flat to buy out my partner from the house we bought together? | Capital gains tax & More Latest News Here


Q My partner and I are splitting up, sadly, but amicably, after 12 years together. We have two children, aged eight and six. The issue has become how we afford the new living arrangements without uprooting the kids from the area, and their friends and school. We want to share custody and stay where we currently live. At present, we rent a flat for her while I stay in the house we bought together. We are both happy with this arrangement as are the kids.

Our joint account pays for the rent and the mortgage until we can organise the long-term solution – worked out at the separation service Relate – which is for me to buy her out. But because the area where we live is becoming increasingly pricey, this could be a financial struggle.

The house we bought together is worth £825,000, with a joint mortgage of £450,000. The mortgage is interest only and for the next two years is fixed at £670 a month. The hefty equity in this property was largely a result of my remortgaging my old flat, which I bought for £190,000 in 2001 with a mortgage of £150,000. The flat is now worth at least £900,000 with an interest-only mortgage of £425,000, which comes to an end in 13 years’ time and which coincides with my retirement date. The monthly interest-only payments will soon be £1,271 from rent of £2,500.

The recent increase in rates means the property perhaps should be sold. This would raise the finance to buy my partner out and we can move on, sharing the kids. However, if I sell it without living back in it for two years to negate the tax, I face a capital gains tax (CGT) bill of £100,000 or more. This would reduce the funds necessary for me to live in the current house. We would then raise £400,000, with £200,000 to pay my partner, and £200,000 to pay the mortgage down to £250,000. However, this is not enough to let me live there affordably, given my age and limited mortgage term and the two kids on my monthly income of £3,200.

But I can’t move back into the rental property and switch to a residential mortgage because I can’t afford it. I suspect that because the mortgage on my flat is a buy-to-let, my mortgage lender wouldn’t let me live there anyway. If I stomach the £100,000 tax bill on the flat I cannot afford then to buy out my partner and afford the remaining mortgage of about £250,000 without the rental income from the flat.

I work part-time, earn £50,000 and am 55. My partner is 42, works full-time and earns £74,000. I could work full-time but the hours do not suit childcare.

A You are not the first person – mistakenly – to believe that you can get out of paying capital gains tax on a property by moving back into it for two years but you can’t. It’s a myth. What is true is that having lived in a property as your home that you subsequently rented out does reduce the CGT bill but it doesn’t cancel it out altogether. The proportion of the gain that is exempt from CGT is calculated using the time apportionment method. So you take the number of months that the property was your home and add nine. Divide this figure by the number of months of ownership and multiply by 100 to get the percentage of the gain which is tax free. The total gain is the sale price less the purchase price less legal and estate agent fees and also any stamp duty land tax you paid when you bought the flat. Your annual CGT allowance then reduces the gain by £12,300 (in the 2022-23 tax year).

Looking at your figures, if you sold the flat for £900,000, you would make a gain before deductions of £710,000. After subtracting your CGT exempt amount of £12,300, you would have a taxable gain – after guessing at £7,700 in fees and so on – of £690,000. Assuming the gain would make you a higher-rate taxpayer, your CGT bill would be £193,200. After paying the tax and clearing the £425,000 mortgage, you would be left with a cash lump sum of £281,800. This is more than enough to pay your partner £187,500 for her half-share of the equity in the house (£825,000 minus the £450,000 mortgage with the result divided by two). It would also leave you with £94,300 to reduce your £450,000 mortgage to £355,700 (rather than £250,000). Assuming the interest rate is 1.79%, your monthly payment would go down to £530, which represents just under 17% of your monthly income.

Want expert help finding your new mortgage? Use our online tool to search thousands of deals from more than 80 lenders with the Guardian Mortgage Service, powered by L&C.

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