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 April 2003. Older articles are accessed through our main Property Tax page.

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Isis Financial Planners offers tax planning advice as well as a Tax Self Assessment Service.

We live in a farmhouse on a working farm. We want to develop a large oast house in the farmyard and then let out one of these houses and live in the other. In about 10 years' time we will probably want to sell both houses and the farm and retire. How could we best organise any living arrangements to take maximum advantage of Capital Gains Tax (CGT) exemption on principle private residence? Should we live in one, then sell it and move into the other and then sell that one? Ideally, we would like to retain ownership/control over both until we decide to sell up.

Maggie Fleming writes:

If each property is, at some stage in your ownership, your main residence, each will qualify for a measure of principal residence relief on sale. In particular, the final three years of ownership would be treated as exempt, as would up to a further £40,000 if you had also let the property at some point. Clearly, this is an extremely generous relief and the Inland Revenue will look carefully at cases where they feel people may be manipulating the facts in order to claim the relief.

In extreme cases, the Revenue can deny relief on the grounds that someone bought or developed a property with the intention of making a gain on its sale. Or they could treat the gain as a trading profit rather than as a capital transaction. This is unlikely in your circumstances, as you will be keeping the property for 10 years prior to sale, but you should discuss this matter with your accountant.

If you live in the oast house with the genuine intention of making it your home, and nominate it as your main residence, relief should be due. Relief will also be due on the farmhouse, as it has been your main residence to date. It may be that, even after all reliefs, there is a chargeable gain on sale of the oast house - if that is the case, you may wish to sell it in a different tax year from the other sales in order to use up your annual exemption. If you are married, you and your spouse should hold the property jointly.

Last year I inherited my father's half-share of my parents' home. My mother and I are now tenants in common. The house is not my main residence. If I later inherit my mother's share and sell the property, how can I avoid paying Capital Gains Tax (CGT) on that portion? Can my mother write in her will that the house must be sold to form part of her estate so it becomes potentially liable for Inheritance Tax (IHT) only? Otherwise, I could be paying IHT and then CGT on the gain when I sell.

Maggie Fleming writes:

You will not pay CGT on your mother’s share of the property provided you sell it shortly after her death. Your mother's half-share will automatically form part of her estate and IHT will be due if her total estate exceeds £250,000. You, however, will inherit her share at probate value, which is equivalent to market value less a possible discount to take account of joint-ownership. So there should be little or no gain if you sell the property right away. If you hold on to it, the gain on this half will be based on the growth in value between your mother's death and the date of sale.

The gain on the share you have inherited from your father is likely to be more substantial, as you will have acquired that half at probate value at the date of your father’s death – I am assuming that the value of the property will continue to rise.

The calculation of the gain is complicated, as you will have two separate dates and deemed costs of acquisition and two different periods of ownership. The two halves will, in effect, be treated like separate assets for the purposes of the calculation.

If you are married, the gain could be mitigated by owning the property jointly with your spouse. Alternatively, you may consider keeping the property on after your mother's death and occupying it as your main residence at some point in the future.

My house in Bloomsbury, London, has been valued at £1.6 million. It was built in 1694 by Nicholas Barbon. My solicitor tells me that its value would be wiped out in death duties. I am willing to give it to my two children, on condition that I continue to live there for the rest of my life (I will be 80 in July). I have been told that it would be possible to create some sort of trust to prevent the children selling the house over my head if they should suddenly be in great need of money. They both own their own houses. Is there any way in which such a trust could be set up without being very expensive?

Maggie Fleming writes:

I am sorry to say that you cannot gift the property to your children while continuing to live in it. This is considered a "gift with reservation of benefit" and the taxman would ignore it and include the full value of the property in your estate on death and tax it accordingly.

There are a number of sophisticated schemes which use trusts to enable you to achieve your objectives. One of these involves selling the property to a trust that has no money but which gives you an IOU that you gift to a second trust of which your children are the beneficiaries.
As you have sold, not gifted, the house, you can continue to live in it without breaching the "gift with reservation" rules. The house is owned, not by your children, but by trustees who have a duty to house you written into the trust deed, and therefore the house could not be sold over your head.

An alternative scheme involves splitting the freehold and the leasehold interests. A long reversionary lease is granted to your children but does not commence immediately. Both schemes are complex and neither has yet been tested in the courts.

There has been much publicity about them recently and it is likely that the Chancellor will move to plug these perceived loopholes sooner rather than later.

These schemes are expensive. Your solicitor can give you a better idea of the cost but it is likely to be more than £4,000. Provided that any such scheme is watertight, however, it could save you more than £500,000 in inheritance tax.