Property auction home >> Property auctions articles >> Watch out for the Capital Gains Tax Trap - By Daniel Feingold and Amer Siddiq Tax Article

Given the property boom over recent years, a huge number of investors have quickly and successfully grown portfolios by using a very simple investment strategy. This strategy involves withdrawing equity from an existing property to fund the next purchase.

Though this strategy has been successfully used to quickly grow portfolios and increase the number of millionaires in the country, it is has already caused and continues to cause severe CGT implications for a growing number of investors.

Consider the following Case Study:

Case Study
Aleesha buys her first two-bed terraced investment property in January 1996 for £60,000.

This is funded by a £12,000 deposit and a £48,000 buy-to-let mortgage. In January 2000, the property is valued at £100,000, so she decides to fund her next investment property by releasing equity from the existing one.

Her mortgage lender allows her to increase her mortgage borrowing to £80,000 (i.e. 80% of the property value) and therefore she is able to buy a £150,000 three bedroom detached property with the 20% deposit funded by the equity release.

Now there is one very important point to note about the above case study. This is that there is no capital gains tax (CGT) liability due when the property is remortgaged. CGT is only due when the property is sold or transferred. So what this effectively means is that Aleesha is able to extract large sums of money from her property without paying a single penny in tax. In fact, even if she had used the equity release proceeds for a cruise around the world then still no CGT liability would have been triggered.

However, this is a very risky strategy as we are about to realise.

Aleesha continues her portfolio growth

In 2002, Aleesha’s first property is worth £150,000 and the second property is worth £200,000. Again she decides to grow her property portfolio and remortgages the existing properties. She again releases equity to fund FIVE new apartment purchases at £125,000 in the North of England.

Due to the competitive buy-to-let market she is now able to remortgage the properties to 85% of the property value. This means that on her first property she is able to increase her borrowing to £127,500 – more than twice what she originally purchased the property for.

So Aleesha now has FIVE properties with a market value of £125,000, one at £150,000 and another at £200,000. Her total portfolio is worth £975,000 – almost a property millionaire!

Aleesha becomes a property millionaire!

By 2004, the north has had two years of excellent property capital growth and the apartments purchased at £125,000 are now worth £175,000 each, her two bed terraced property is now valued at £175,000 and three bed detached property is valued at £250,000.

She is now a property millionaire!

Again, Aleesha is keen to continue the growth of her property portfolio and once again takes advantage of the 85% equity release available and remortgages all the properties to 85% loan to value and invests in three Villas one in each of Spain, France and Cyprus for £250,000 each.

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