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 July 2006. Older articles are accessed through our Archives page.

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This week, Maggie Fleming on the perils associated with gifting property with reservation.

Why the big fuss about "with reservation"?

Since Inheritance Tax (IHT) was first introduced, taxpayers and their advisers have racked their brains in attempts to get round the "gifts with reservation of benefit" (GWR) rules. These state that a gift is ineffective - it cannot be treated as a gift - if the donor retains a benefit in the asset gifted.

The most common example is where elderly parents gift their home to their children, but continue to live there. HM Revenue & Customs (HMRC) does not regard this as a genuine gift, and so it does not fall out of the parents' estates after seven years, as an outright gift would.

Surely some smart accountant has found a way round the rules?

Over the years, people did succeed in circumventing the rules, often by means of complicated trust or lease schemes. Finally, the Government introduced the Pre-Owned Assets Tax (POAT) to stem the leakage of tax.

The basic rule is that if you are caught by the GWR rules, you are not subject to POAT.

What if I do not want to pay either?

You can pay your children a commercial rent for the property. Or you could enter a property-sharing agreement with one or more children. HMRC is happy with a gift of 50 per cent of your house - if you gift a larger share, you may have a fight on your hands.

Any other alternatives?

If you are caught by POAT (but not GWR), there is no tax charge if the rental value of your home is less than £5,000 p.a. This limit applies per person, so there is no charge for a couple where the rental value is under £10,000. In effect, this should exempt properties worth less than £200,000.

My wife and I are about to sign a conditional contract with a property developer for the sale of our sole residence, consisting of a house on about a third of an acre of land, at a significant uplift on current market value. The condition is, of course, upon his obtaining planning consent. His application is bound to be vigorously opposed locally and will almost certainly have to be taken to appeal. The developer has said he will go to a public inquiry if necessary, this being worth his while because three neighbouring properties are also involved. All this is likely to take at least a year and possibly as long as two years.

Meanwhile, we have been looking around for a new house and have already found one we want to buy. If we do buy it, move in, and let out our present house on short-term rental pending its sale, would there be a potential liability for Capital Gains Tax (CGT) and, if so, what would be the basis for calculating the gain? Would it be better for us to stay in our present house and rent out the new one on short-term rental until our present one is definitely sold, then move into the new one as our permanent sole residence?

Maggie Fleming writes:

Where a property has at any time been your only or main residence, the last 36 months of ownership are always exempt from CGT. This rule applies no matter what you use the property for during that period. Your plan to rent out the property while awaiting the outcome of the planning appeal is a sound one. Indeed, as there is a further exemption of up to £40,000 (£80,000 where the property is owned jointly) for renting out a property which attracts principal private residence relief, it is likely that the gain would still be exempt even if the sale dragged on for more than three years.

There should be no problem in obtaining exemption for the whole gain (assuming that you have lived in the property throughout your entire period of ownership apart from the final 36 months). The size of the property is well within the limits for relief, as the total area is no more than the "permitted area" of 0.5 hectares. The sale is clearly not trading and the HMRC internal guidance indicates that the sale should not be queried. However, the evidence of my postbag suggests that they do not like sales to developers and occasionally challenge the right to full relief. If this does happen, you should seek professional advice. But, as sales of properties that attract full principal private residence relief do not have to be declared on your tax return, it is unlikely, in practice, that questions would be asked.

My husband and I are planning to retire this year and need to generate retirement income from our properties. In November, we will take ownership of a property in Dubai, and currently own a home in Britain.

Are there any tax benefits in moving to the Dubai home and making this our principal private residence, meanwhile renting out our house in Britain? Would there be issues with the income generated being transferred to Dubai and would it be taxed?

Also, would there be tax benefits to selling our United Kingdom home if we move to Dubai and then buy another British property while resident there?

Maggie Fleming writes:

I can only advise on the British tax position, although I believe that there are no personal taxes, other than a residential tax, in Dubai.

I am assuming that you are both domiciled in Britain. You need to consider whether or not you will remain a tax resident in the UK. This is a complex area but, basically, if you move permanently to Dubai and are careful not to spend more than 182 days in any tax year in Britain, and no more than 90 days per tax year on average, you will be treated as not resident.

You will still be taxable on UK source income but not on any income arising outside Britain. You will be able to use your personal allowances against any UK income, such as rents. You can also apply to receive the rents gross under the Non-Resident Landlords Scheme - otherwise your agent (or tenant) would be obliged to deduct tax before sending you the balance. If you remain resident in the UK, your worldwide income is taxable.

If the UK property has been your only or main residence up until now, there will be no Capital Gains Tax (CGT) on sale. However, it is worth remembering that you cannot be charged CGT if you are not resident and not ordinarily resident. Therefore, if you were to buy and rent out a further UK property while resident in Dubai, there would be no CGT on the subsequent sale of that property, even though you had never lived in it, provided that you were not resident and not ordinarily resident in the UK when you sold the property.

There are some anti-avoidance measures regarding temporary non-residence, so seek professional guidance.

Our house and smallholding is now too big for us and we plan to sell the property and a third of the land to move to a smaller house. The remaining land has several stone outbuildings, one of which we would like to convert to a four-bedroom house. Our plan is to sell this house, along with the remaining land, to provide us with a pension in our old age. However, as it would no longer be our main residence, would this second sale be subject to Capital Gains Tax (CGT)? If so, would it be better to live in a mobile home on the unsold land while the outbuilding was being converted, rather than move away?

Maggie Fleming writes:

Your situation was the subject of a famous tax law case, Varty v Lynes, in 1976, and that decision still stands. Because of the precise way in which the legislation is worded, the sale of the converted building and remaining land will be subject to CGT. Land will not be covered by the principal private residence exemption if sold after the disposal of the house - the test is its use at the time of disposal. Living on site will not make any difference.

Even if you did not sell your house first, there is a question mark over whether the outbuildings and land would qualify for relief in the first place. To qualify, the outbuildings must be geographically close to the main residence and within its curtilage. It will also depend on their use.

For land to qualify, it must be garden or grounds occupied by you for the enjoyment of your residence, with a total area of no more than half a hectare (if sold at the same time as the residence). If the total area is greater, you would have to convince HM Revenue & Customs that the extent of the grounds was appropriate to the size and character of the house. If the land has been used for agriculture or trade, it will not qualify for principal private residence relief.