Property and Tax Issues

Isis' Maggie Fleming answers readers questions in Saturday's Daily Telegraph newspaper for the Property Clinic section.

The questions and answers are reproduced for you here.

This page contains Questions & Answers from February 2006. Older articles are accessed through our Archives page.

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In June 2000, my wife and I bought a buy-to-let property which we have been letting to students from the local university. In October 2003, we remortgaged the house in order to free up sufficient capital to buy two more buy-to-let properties, which we have subsequently let. We now wish to sell the student house in order to use the capital to buy another house for family letting.

We paid £51,500 for the house, remortgaged it to release £72,250 when it was estimated to be worth £85,000, and estimate its current market value as about £100,000. We are concerned about capital gains tax (CGT). Would we be required to pay it on the difference between our original purchase price and its current value, or could we use the remortgage price? Could we also set the costs of the kitchen extension, fire alarms, fire doors and double glazing against CGT?

Maggie Fleming writes:

Mortgages and remortgages are irrelevant for CGT purposes. The gain is calculated on the difference between the price you paid for it and what you sold it for. You can deduct the incidental costs of purchase (such as stamp duty and solicitors' fees) and the incidental costs of sale (usually estate agents' commission and legal fees).
There is also taper relief. You have owned the property for five years and therefore 15 per cent will be knocked off the gain. If you don't sell the house until after June, when you will have owned it for six complete years, a further 5 per cent will be deducted, so that only 80 per cent of the gain will be chargeable. As you and your wife own the property jointly, you will each be taxed on half the gain and will each have the benefit of your own annual exemption (currently £8,500, but due to go up in April).

As for the additional expenditure you mention, the rule is that expenditure on improvements must be reflected in the state of the asset at the time you sell it. It must also, of course, be capital, rather than day-to-day expenditure and must not already have been claimed as a deduction from the rental income you showed on your annual tax returns. Provided you have not, in the meantime, removed any of the items you mention, I would judge them allowable as a deduction in the capital gains calculation.

It rather passed me by in the pre-Christmas rush but hasn't Gordon Brown suddenly got cold feet over these new Sipps?

Yes, in his pre-budget report in December, the Chancellor did a good Scrooge impersonation by clamping down on the assets which people can put into their pension schemes from April 6, when the rules change to make pensions simpler and more flexible.

Turning into too much of a good thing, was it?

Well, many investors had been looking forward eagerly to being able to stuff assets such as art, antiques, fine wine, classic cars and especially residential property into Sipps (self-invested personal pensions). But, just four months before the changes were due to come in, the Chancellor decided that these assets would not, after all, qualify for inclusion in pensions. His ostensible reason was that it would leave the system open to "abuse", in that people could put their holiday homes into their pension schemes - with all the tax advantages that entails - and then enjoy personal use of them.

Bit of a risky decision by our prime minister-in-waiting?

No doubt there were other (in my view, more valid) factors involved. For a start, there are the social consequences of pushing property prices up, often in areas where locals can't afford to buy. And then there's the potential for mis-selling - it was clear that it was going to be a popular measure but at the same time not suitable for everyone.

So property is out of the equation for Sipps now?

Not quite. While people won't be able to invest Sipps directly in residential property, it seems that they will be able to invest in REITs (real estate investment trusts) when these are introduced later in the year. These are collective investments, similar to unit trusts, but they invest in commercial and residential property rather than in shares. Because investors' money is pooled and spread over a number of properties, it is less risky than direct investment in a property.

Some might say that is a good thing?

With any investment, it is always wise to diversify. A sensible approach to pension planning is to spread investments across the various asset classes - equities, bonds, cash and property - rather than to invest in just one.

My husband is a 40 per cent tax payer and I pay at 22 per cent. We are looking to buy a second house for about £200,000 out of our savings as a buy-to-let investment. Bearing in mind our different tax levels, could we elect to have the rental income paid mainly to myself as I have the lower rate? Is this the best tax option?

Maggie Fleming writes:

If the house is owned jointly, you will each be taxed on 50 per cent of the income unless you actually own the house in different proportions and elect to have the income taxed on that basis - you cannot just decide that the spouse with the lower tax rate will pay income tax on the whole rental profit.

You may wish to consider purchasing the property in your sole name, so that you are assessed on all the rental income. When the time comes to sell the property, you could gift half of your interest to your husband, if this were to your advantage from a capital gains tax (CGT) point of view. All transactions should be properly documented, you should have the right to enjoy the income and the gift should be on a "no strings attached" basis.

If you have a mortgage on your main residence, you may want to think about paying it off and getting a mortgage to fund the purchase of the new rental property instead - this is because mortgage interest paid on a buy-to-let property attracts tax relief, while loan interest paid on your home does not. If the property is put in your name, you should pay the loan interest personally.

In 1997 we moved out of Britain to work abroad. Our 16-year-old son did not want to join us and wanted to stay in the area where he had been brought up. We assisted in this by purchasing a property in our name for him to live in rent-free and as a place for us to stay on our frequent return visits.

He now pays all the bills and maintenance costs at the house and we had a verbal agreement that we would sell it to him at the original purchase price when he could get a mortgage. However, the market value of the property has doubled and we are concerned about any Capital Gains Tax (CGT) on the difference between the two figures. Also, what would apply if he resold the house within six months?

Maggie Fleming writes:

This will depend very much on your exact residence status and I suggest that you consult a tax practitioner to go into the matter in detail. For the purposes of this answer, I have assumed that you have been considered not resident and not ordinarily resident in the United Kingdom since 1997. This is likely to be the case if your visits to the UK average less than 91 days per tax year (and total less than 183 in any single tax year).

If this is the situation, you will have no CGT to pay on sale of the property to your son because you have been non-resident for at least five complete tax years. The sale will be deemed to take place at market value, however, because of your family relationship and the current market value will be treated as your son's acquisition cost. If he sells the property in six months, he will have no CGT to pay either, provided that it has been his only or main residence during his period of ownership.

If you are planning to return to the UK in the future, you should ensure that you sell the property before you return, or you could face a substantial CGT bill. Indeed, to be on the safe side, it would be best to sell it in the tax year before your return.