Downsizing can be a great way to unlock money tied up in your home, while also enabling you to move to a property that better suits your needs.
But there are tax impactions that you need to consider before you go ahead. Let's take a look at the different tax issues there are to think about.
What are the tax implications of downsizing a home?
Unless you are moving to a very cheap property, downsizing is likely to land you with a stamp duty land tax bill.
Under certain circumstances, you may also have to pay capital gains tax when you downsize your home.
On the plus side, the move could lead to you paying less inheritance tax when you die, while your annual council tax bill may well also be lower.
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Do you pay stamp duty if you’re downsizing?
Although you don’t pay stamp duty when you sell a property, you are likely to have to pay it when you purchase your new one.
The good news is that if your new home costs up to £250,000, you won’t have to pay any stamp duty.
For homes with a purchase price above this amount, stamp duty is charged at the following rates:
| Property price | Stamp duty rate |
|---|---|
| Up to £250,000 | 0% |
| £250,001 to £925,000 | 5% |
| £925,001 to £1.5 million | 10% |
| £1.5 million and above | 12% |
So for example, if your new home costs £300,000, you will pay:
0% on the bit between £0 - £250,000 = £0
5% on the bit between £250,000 - £300,000 = £2,500
That's £2,500 in stamp duty.
Is there a government grant for downsizing?
While there are financial incentives for people who rent a council house to downsize, there is currently no scheme to help people who own their own home.
In the past, think tanks have called for stamp duty breaks for people downsizing, similar to those offered to first-time buyers.
The Government has previously touted plans to enable more developers to build high quality sheltered homes to encourage older homeowners to move to smaller properties and free up family homes.
But it has stopped short of introducing financial incentives for homeowners themselves.
Do I need to pay tax if I sell my home?
You do not need to pay stamp duty when you sell your home, although you are likely to need to pay it on the property you buy.
Under certain circumstances you may need to pay capital gains tax when you sell your home.
You will not have to pay income tax on the money you unlock from your home by downsizing.
Will I pay capital gains tax if I sell my home?
You will not have to pay capital gains tax when you sell your home as long as you meet the following criteria:
You have lived in it as your main home all of the time you have owned it.
You have not rented any of it out or used part of it for a business.
The land your home is on is smaller than 5,000 square metres or just over one acre.
If you do have to pay capital gains tax on your home, it is charged at a rate of 18% on any gains for basic rate taxpayers and 28% for higher rate ones.
Gains means the difference between the amount your home was worth when you bought it and the amount you are selling it for.
You have a capital gains allowance of £12,300, and if you are part of a couple, you can combine this allowance.
As a result, you won’t pay tax on the first £24,600 you have made.
You may also be able to claim private residence relief and letting relief, which would further reduce the bill.
How much tax do I pay if I sell my house?
In the vast majority of cases, the only tax you will have to pay is stamp duty on your new home.
The amount of stamp duty you pay will depend on the purchase price of your new property, as set out above.
Stamp duty is paid at the same rate on specific retirement properties as it is on normal family homes.
Will downsizing mean I pay more inheritance tax?
No. Inheritance tax is paid on the first £325,000 of assets you leave behind, rising to £500,000 if you leave your home to your children and grandchildren, and your estate is worth less than £2 million.
If you are married or in a civil partnership, you can transfer any unused allowance to your partner when you die.
As a result, their threshold could be as high as £1 million.
If you downsize your home, you will not waste this allowance even if your new home is worth less than £175,000 – the difference between the £500,000 threshold if you leave a property to your children and the £325,000 one if you do not.
That is because under the rules, each parent will still be able to leave assets worth £500,000 tax-free.
Are there any tax benefits to downsizing?
The obvious tax benefit of downsizing is that you are likely to pay less council tax if you move to a smaller, cheaper property.
If you are clever, downsizing could also reduce your inheritance tax bill if you give away some of the money you unlock before you die.
You can give away £3,000 of money or possessions each tax year free from inheritance tax. This is known as the annual exemption.
In addition, you can give money to someone tax free if they are getting married. You are allowed to give £5,000 to a child, £2,500 to a grandchild or great-grandchild and £1,000 to anyone else.
If you give away a larger sum, inheritance tax will not be paid on it as long as you live for you at least seven years afterwards.
This is known as the seven-year rule.
Should I consider equity release instead?
The potentially high level of stamp duty that you might be liable for when downsizing is thought to have put many people off moving.
For example, if you downsized from a £600,000 home to a £400,000 one, you would pay £10,000 in stamp duty.
While this may sound a lot, equity release could work out to be more expensive.
If you unlock £200,000 through equity release at a rate of 3.5%, you would pay around £7,000 in interest in the first year alone.
That said, interest on equity release mortgages is ‘rolled over’ and only paid when you die or sell the property.
You also have the option of taking out a drawdown equity release mortgage, under which you only unlock equity from your home as and when you need it, which reduces the amount of interest you pay.
It is important to weigh up the pros and cons of both downsizing and equity release.
It is also a good idea to consult a financial advisor before going ahead with equity release.
Equity release: is it right for you?