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.

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We have a holiday property, A, purchased in 1982 which even given the relevant allowances, is subject to a significant capital gain (CGT). For the last and this tax year, the property will qualify under the holiday-let rules.

We also have a one-third share in another property, B, which has similarly qualified for this and the previous two tax years. We are considering selling A and buying the remaining two-thirds interest in B. The sale price of A will roughly equate with the purchase price of B.

Will the sale of A crystallise a capital gain or can it be rolled over into property B and eventually mitigated by the additional relief given under holiday lettings?

Maggie Fleming writes:

Properties that qualify under the furnished holiday lettings (FHL) rules for income tax purposes also qualify for beneficial CGT treatment - the rental business is treated as a trade in any year when the requirements are met. However, while relief for replacement of business assets (rollover relief) will apply, you will only be able to defer that part of the gain which relates to the period when it qualified as an FHL.

On the information you have given, it would seem that roughly a 12th of the gain could be deferred. In addition, to get the maximum deferral, you must reinvest at least one 12th of the proceeds in the new property - although that is not a problem in your case.

The balance, approximately 11/12ths of the gain, will be immediately chargeable to CGT, although it will benefit from taper relief, whereas the gain which is rolled over is calculated before taper relief and will therefore lose the relief that has accrued.

Rollover relief works by deferring the gain made on the first asset until such time as the second asset is sold, when it comes back into charge. There are strict time-limits for purchasing the replacement property - it must be acquired within the period running from one year before until three years after the sale of the first property. A claim must be made for the relief and it is possible to make a provisional claim to defer tax where you have sold the first asset but not yet acquired the second. This is a complex subject and you should seek professional assistance.

My father died recently. He was 81 years old, a widower and left no will. Eleven years ago, and without seeking any advice, he transferred the ownership of his house to my sister and I under deed of gift. However, he stayed living in the house, did not pay rent and paid all the repair bills.

Under the Inheritance Tax (IHT) rules, the house is deemed to be a gift with reservation and must be included in his estate for the calculation of IHT. As the house is worth £100,000, there is a potential tax liability of £40,000.

However, I have also been told that since the house legally belonged to my sister and I since 1995, we will be eligible for capital Gains Tax (CGT) on the difference between what it was worth in 1995 (£36,300, according to the Nationwide House Index) and what we sell for. That is a potential CGT liability of £25,480.

This means we have a potential tax liability of £65,480 on an asset of £100,000. Surely this cannot be correct?

Maggie Fleming writes:

Unfortunately, this could be correct. It is a perfect illustration of how "do-it-yourself" tax planning can make things worse instead of better. For IHT purposes, the gift of the property was ineffective, as it was a gift with reservation of benefit - your late father reserved to himself the benefit of living there. For that reason it forms part of his estate on death. But what did the rest of your father's estate consist of?

If his total assets, including the house, less liabilities, were less than £285,000 at the date of death, the entire estate is within the "nil-rate band" and there is no IHT payable.

The CGT position is not as black as you paint it. I suggest that you contact a local estate agent and valuer to obtain a more accurate 1995 valuation. You and your sister will also benefit from a number of reliefs, including indexation allowance and taper relief, and you are each entitled to annual exemption of £8,800, which will knock off £17,600 right away.

The chargeable gain will be taxed at your marginal rates, so unless you are both higher-rate taxpayers, the gain will not all be taxed at 40 per cent.