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

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We wish to rationalise our property within our family by swapping part-ownership interests in one property with that of roughly equal value. We have been told that we may have to pay substantial Capital Gains Tax (CGT) despite the net gain after the transfer of equity being roughly zero.

In 1992 my wife and I helped our daughter buy a house, which she occupies as her primary residence. The house cost £48,000 and is now worth about £180,000; we have spent about £10,000 on repairs. My daughter and I are joint owners and mortgagees.

In 1999, we bought a second house nearby specifically to assist my elderly mother and father. This was purchased at £96,000 and is currently valued at £210,00; and we spent about £15,000 on repairs. My daughter, my wife and I are co-owners.

Now that my daughter is a mother and is likely to marry soon, we would like to transfer ownership of her primary residence to her in return for her third share in the second house, now occupied only by my father. We have no intention of selling either property in the near future and do not wish to pay any CGT until we do sell. Can you advise?

Maggie Fleming writes:

I wrote last week about an HM Revenue & Customs concession which enables people to exchange their interests in two jointly held properties, so that each ends up owning 100 per cent of their own main residence, without having to pay CGT. Unfortunately, this concession would not apply in the circumstances you have outlined.

Therefore, any change in the way the two properties are held would not be looked at as one transaction but as two separate transactions. If you gift your half-interest in her house to your daughter, you would be taxed just as if you had sold it at open- market value. Incidentally, if you should decide to do this, you should first transfer half of your interest to your wife - that way, you can each use up your £8,800 personal exemption on the subsequent gift to your daughter. Even so, the tax payable is likely to be considerable. However, if you hold on to your interest and the property grows in value, the tax bill on eventual sale will be worse, as, unlike your daughter, you cannot claim principal private residence relief. So it may be better to grasp the nettle now.

Similarly, if your daughter were to gift her third of your father's home to you and your wife, she would have a CGT liability based on the difference between current open- market value and purchase price. If she decides to do this, she could wait until she marries and transfer half her interest to her husband. Any inter-spouse transfers must, of course, be outright gifts, on a "no-strings attached" basis.

My wife and I bought a second property two and a half years ago. Within a few months, my wife decided to move away and has lived in this property for about the past two years. We still have joint mortgages on both these homes but she has taken over responsibility for all the bills, including mortgage payments on the second property. I do the same for the first. In short, we both have a separate house which is our main residence.

Until now, we have not taken any legal steps to dissolve our marriage, but this is just a matter of time. What action do we need to take so we do not get caught up in paying Capital Gains Tax (CGT)? Do we need to inform the Inland Revenue even though we have not taken any legal steps to dissolve or to formalise our separation?

Maggie Fleming writes:

You are clearly aware that a married couple living together can have only one residence qualifying for the principal private residence exemption at any time. However, once you separate, you are each entitled to your own exempt residence. You do not have to be formally separated - it is sufficient that the circumstances are such that the separation is likely to be permanent. You and your wife should therefore agree on when the separation took place and then advise HM Revenue & Customs accordingly.

I am assuming that both properties are owned jointly. If that is so, there could be tax complications on sale of either property in the future, as you are each part-owners of a property in which you do not live. This is especially true of the second property - as this has never been your only or main residence, you would have no claim to principal private residence relief on a future sale. And now that you have separated, you can no longer make use of the tax-free inter-spouse transfer exemption that applies to married couples living together.

However, there is a little-known HMRC extra-statutory concession (D26) that allows people in this situation to exchange their interests in the two properties without incurring a CGT charge. Each of you ends up owning 100 per cent of the property he/she lives in - this means that you would each be entitled to the full principal private residence relief on the sale of your "own" residence. I have had a look at the wording of the concession and can see nothing to prevent separated spouses using it.

My wife and I purchased a terraced house in 1993, which was divided into three flats all with leases. We also managed to buy the freehold. The prices paid were £19,000 for one and £17,400 for the other two.

We have let these flats furnished over the 13 years and have paid tax on the income, but now we would like to sell them without paying too much Capital Gains Tax (CGT). They have been valued at about £85,000, £65,000 and £62,500. Should we sell one flat a year, or two this year and another in 2007 or even all three this year? It may be slightly complicated as we would like to sell the freehold jointly to the buyers. There are still about 85 years left on the leases.

Maggie Fleming writes:

From a tax point of view, it would be better to sell each flat in a different tax year. That way you and your wife can make full use of your personal exemptions (currently £8,800 per person) each year. Therefore, on the sale of one flat in the current tax year, the first £17,600 of the gain will be tax-free. In addition, unless you are both higher-rate taxpayers, spreading the gains over three years will mean that at least part of the gain each year will be taxed at basic rate.

Once the two sets of personal allowances, indexation allowance and taper relief (which would knock 35 per cent off the gain in the current tax year) are taken into account, the CGT payable should not be too onerous. You can also deduct the incidental costs of purchase and sale (Stamp Duty and legal and estate agent's fees) and the cost of any capital improvements which are still apparent in the state of the property.

You can also deduct the cost of any valuation necessary for tax purposes. This may be required if you do not sell the freehold interest at the same time as the leasehold interest. This is a complex matter and you should obtain professional assistance.

My sister, brother-in-law and I each have an equal stake in a modest property. It was purchased for £70,000 a few years ago with a £55,000 mortgage; each us put in £5,000. It is now valued in the region of £120,000.

The property has been rented to tenants for the last couple of years but we are now considering selling it. We have thought about forming a limited company to manage the property and future possible purchases.

Can you advise us on the possible financial benefits that might accrue were we to form a limited company? Moreover, by forming a limited company, will it be possible to limit the amount of Capital Gains Tax (CGT) due on the property if we do decide to sell? The property in question is not our principal home.

Maggie Fleming writes:

I cannot give you a definitive answer - it will depend on your precise circumstances and whether you envisage the company as a short-term or long-term business.

However, I can point out some of the advantages and disadvantages of incorporating your business. The main advantage is that small companies pay a lower tax rate on rental income than most individuals - 19 per cent. The shareholders can choose to take their remuneration as dividends and, if they are basic-rate taxpayers, they will have no further tax liability on these.

There are disadvantages as well. The company would pay corporation tax at 19 per cent on the entire gain on the sale of the property, as companies do not enjoy an annual CGT exemption. If you sold it as individuals, you would each be entitled to exemption on the first £8,800 of your gain. You as individuals would also be entitled to taper relief if you had owned the property for at least three years before its sale. Companies do not enjoy taper relief, although they do still have indexation allowance, which was abolished for individuals in 1998. Another disadvantage of companies is the amount of administration involved, resulting in higher professional fees.

There is also a double charge to CGT - the company pays tax on property gains and you will eventually pay CGT on the disposal of your shares in the company.

As you already own the property outside a company, any transfer to a company would result in a capital gain, although this could be deferred until you dispose of your shares in the company. You should consult an accountant, who can also advise you of any Stamp Duty Land Tax implications.