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 2008. Older articles are accessed through our Archives page.

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We own a three-bedroom farmhouse and have spent the past five years converting the cowsheds within the curtilage into two holiday cottages. The work is just complete and we have not let them out yet. If we sell the whole as one unit, will we be liable for CGT?

Maggie Fleming writes:

I assume you intend to let the cottages out in the future. You will be holding them as a long-term investment, so there will be capital gains tax on eventual sale. (If you had planned to sell them right away, you could be charged to income tax as property developers.)

The assets that qualify for tax relief as your only or main residence are the dwelling you live in, together with land you occupy and enjoy as your garden or grounds. The cottages fall into neither category.

The cases where curtilage is relevant are usually where a subsidiary building is sold and a case is made that it serves the taxpayer's occupation of the main house in some way - a garage, perhaps, or fuel store or as accommodation for servants. Provided that the outbuilding is geographically close to the main house, it can then be regarded as part and parcel of it and relief should be due. This is not the case with your cottages, which are independent entities and let commercially.

If you sell the whole as one unit, the gain will be apportioned between the farmhouse and permitted grounds, which will be exempt from tax, and the cottages, which will be taxable. The costs of conversion will be allowable deductions from the gain. There are some income tax and CGT advantages to be had if you can bring the cottages within the rules for furnished holiday lettings. Your tax office will be able to give you information on this matter.

My mother lives in a care home. Most of her assets are in a discretionary trust and exempt from Inheritance Tax. Presumably, my sister and I will be liable for Capital Gains Tax when we sell her house? If so, how will that be calculated? Would it be better for my mother to sell and keep the money in a bank account because it is her only home so she won't pay CGT?

Maggie Fleming writes:

I assume the house is not in the discretionary trust (in which case only the trustees could sell it), so, if its value is in excess of the nil rate band available on your mother's death, Inheritance Tax would be due on it. There may be a reduced nil rate band available if she dies within seven years of making gifts into the trust.

As far as CGT is concerned, it would seem to make little difference who sells the property; there is unlikely to be a tax liability. I assume it has been your mother's only or main residence for the entire period of her ownership apart from the final three years, which are always exempt.

When you and your sister inherit it, your base cost for CGT will be the probate value; the gain will be based on sale proceeds minus its value at the date of your mother's death. Therefore, if you sell it shortly after her death, any gain should be within your and your sister's combined annual exemptions - now £9,600 per person. If you are married, you could gift shares to your spouses so as to make use of their allowances, too, if the value of the property were to increase substantially between her death and the sale.

What you should do is check with a solicitor what implications both courses of action could have for the funding of your mother's care.

How do I calculate how much tax to pay on my buy-to-let?

When preparing your tax return for the year ended 5 April 2008, get all the invoices relating to the property together and sort them into categories. Recent newspaper stories have accused the Inland Revenue of being far too generous over the expenses that buy-to-let landlords can claim to reduce the income tax liability on their rental income. In fact, the rules are broadly similar to those that apply to any other type of business. The expenses must have been incurred wholly and exclusively for business purposes and must not be of a capital nature. So, while repairs such as redecorating the property are allowable, the cost of building an extension is not. (Some capital expenses may be allowable against the capital gain when you sell up.)

So what exactly can I claim?

The most common expenses are insurance, repairs and safety checks, letting agents' fees (including the VAT element) and mortgage interest. Depending on the circumstances, you may also have paid water rates, council tax, ground rents or the cost of garden maintenance. You may have advertised for a tenant or paid a subscription to a landlords' association. Finally, if you are letting the property furnished, you can also deduct a wear-and-tear allowance of 10 per cent of net rents (ie gross rents less water rates and council tax paid by the landlord). If the property is let unfurnished or partly furnished, you can claim the cost of replacing fixtures or worn items of furniture.

Is there any way of reducing my tax liability?

Mortgage interest can be a major expense and is often enough in itself to create a loss, resulting in no income tax at all being payable on the rental income. It is therefore sensible to shift any borrowing from your own home, where it does not attract tax relief, to your investment property, where it does. If you previously lived in the investment property, you could increase the mortgage on it up to its market value at the time you start letting it.