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Hello, I am Keith, one of the experts on Just Answer, and pleased to be able to help you with your question.
You will be liable to Capital Gains Tax (CGT) on the gain made on sale. Before I can fully address this problem I need to know
When you originally bought this house?
On purchase of your second home did you elect to which house you wished Private Residence Relief (PRR) to apply? You had two years in which to do this.
Did you ever live in the original house?
I await your information.
HMRC will apply PRR based on the facts.
CGT will apply to the gain made on sale. Depending upon whose name the first house actually was will depend the liability. You say it was your wife's and I will proceed on that assumption. The gain is the difference between the disposal and the acquisition costs. The former is net ie after deducting selling cost including advertising. The acquisition cost is the price paid plus purchase costs including Stamp Duty plus improvements eg installation of double glazing, central heating, extensions, but not routine maintenance which, for the let period, can be set against rental income for Income Tax (IT) purposes.
The gain exposed to tax is reduced by the time spent living there plus the last 18 months of ownership when you are deemed to be in residence even if this is not the case. I will work in years to give you a rough figure, but actually months are used in this computation. Total ownership time is 22 years. Occupation time is 14.5 years. 22 - 14.5 = 7.5. 7.5 / 22 = say 35% so that percentage of the gain will be exposed to CGT. From this can be deducted the non cumulative Annual Exempt Amount (AEA) of 11.1K and Lettings Relief (LR) up to 40K. The remaining figure is taxed at 18% or 28% or a combination of the two rates depending on the owner's income including the gain in the tax year of sale.
Forget about mortgages, they do not come into the frame at all save that the interest element thereof is allowable against rental for the letting period for IT purposes.
I do hope that you find my reply of some assistance.