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 February 2004. Older articles are accessed through our main Property Tax page.

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We own our house outright (value £250,000, bought 1988). In 2001 we bought a further house for my mother to move into. We bought it for £175,000 and, after spending about £25,000 on renovations, it is now worth £225,000. We also own that house outright.

My mother (a healthy, independent 76-year-old) pays no rent and we pay for the upkeep of her house. Our reason for putting the house in our names was in case she needed to go into long-term care in the future. We didn't want the value of the house to be taken into account in calculating any benefits she may be entitled to. (She has no assets of her own.)

Our concern is what the capital gains tax (CGT) position would be if my mother were to die. Presumably, we would need to pay CGT on the sale of "her" property. Would it be better if we were to transfer the property into her name, with her willing it to us on her death, and hoping that she never needs long-term care?

Maggie Fleming writes:

If the present set-up continues until your mother dies and you decide to sell the house, you and your spouse (I assume that you own the property jointly) would be liable to CGT on the difference between the acquisition-cost of capital improvements and the sale price. The £25,000 renovations would be allowable if they were still apparent in the state of the property at the time of sale. You would be entitled to taper relief once you had owned the property for a full three years and the gain would be split between you. You would each be able to use your personal exemption and the balance would be taxed at your marginal rate.

If you were to gift the property to your mother now, you would have a gain in the region of £25,000, less 5 per cent if you wait until the third anniversary of purchase. Even with the two personal exemptions available, you would each still have a tax liability on the gift. If you do decide to gift the property, there are other tax consequences. While there would be no CGT payable if your mother sold the house or died, it would form part of her estate for inheritance tax (IHT). While the value is currently below the IHT threshold, house prices may continue to rise faster than the nil-rate band and one cannot say definitely that there would be no IHT charge on death.

When my wife and I bought our house in 1967, we did so as tenants-in-common. We then drew up identical wills, leaving each half of the house to our three children in their joint names. Also, in each will is the proviso that after the death of one spouse, the surviving spouse has the right to continue to live in the property until their demise, provided that the property is properly maintained and fully insured.

My wife died in June 1999 and under the terms of her will, I have continued to live in the house and observe these conditions. Because of this condition, our children have been unable to benefit from their mother's will – not that they are concerned – and they understand that they may each have a capital gains tax liability due to the increased value of the property.

I have been informed that because I have the right to continue to reside in the house, this is known as a "life interest" and that on my death, the value of the property must be included in my estate and subject to inheritance tax (IHT). This seems unfair and appears to negate any benefits of the "tenants-in-common" arrangements. Is this correct?

Maggie Fleming writes:

This would have worked perfectly if only you hadn't included the proviso that the survivor enjoys the right to live in the house for the remainder of their life. As you have been advised, such a right may constitute a lease for life, which is equivalent to an "interest in possession" in the whole property. As you say, this will have the effect of including the entire capital value of the property in your estate on your death and does not achieve your original objective. You need to take specialist legal advice to see if anything can be done.

An "interest in possession" or "life interest" is always added to a deceased person's estate and subjected to IHT as though they had owned the property in question outright. Generally, where each parent leaves a share of the family home to the children, the bequest should have no strings attached. This is, of course, fraught with danger, as the divorce or bankruptcy of one of the children, or a breakdown in family relations, could lead to a forced sale of the property.

Ideally, the children will voluntarily settle their share on the surviving parent or revert to settlor trusts. Alternatively, the property could be left to a discretionary trust, of which the survivor is a trustee. On the survivor's death, the remaining trustees will pass the trust share to the children.

I spent most of my working life in residential education, where I lived in tied houses. In 1982, I bought a bungalow to prepare for retirement. My parents, who lived 90 miles away, suffered serious health problems so I moved them into my bungalow to look after them.

On my retirement in 1992, so they could go on living there, I spent all of my savings and my gratuity to buy my own house nearby.

Consequently, by accident rather than design, I own one house and shortly, when the mortage is paid, I will also own the house my parents live in. I don't charge them any rent so the bungalow is not a commercial venture. I'm concerned that when my parents die, and I want to sell one of the properties, will I be liable for capital gains tax (CGT)? I should point out that both properties are the same value, about £150,000.

Maggie Fleming writes:

The house you now live in has been your actual residence since you retired in 1992 and therefore will attract principal private residence relief on a future sale. The position is more complicated with the bungalow you bought in 1982. The property may qualify for relief on several counts, depending on the precise circumstances.

Where a person lives in job-related accommodation, and buys a property which they intend to occupy on retirement, the property will qualify for relief even if, for some reason, the person never occupies it. It will attract principal private residence exemption during the period that the taxpayer intended to make it his future home.

So, it would seem that the property should attract relief on this count up until the point when you decided that you would not occupy it yourself.

The other situation qualifying for relief is where, before April 5, 1988, a property was occupied by a "dependent relative'' – defined by the legislation as someone who is incapacitated by old age or infirmity from maintaining themselves. If your parents qualify, and were in occupation before April 1988, the entire period from when they moved in until the last of them finally vacates the property will be exempt from CGT. This would mean that you would own two properties both qualifying for principal private residence relief at the same time.

As the situation is complex, I suggest that you seek professional assistance if you consider selling either property or if your parents want to move.

My husband and I live in a cottage in London on which we have a mortgage. I am a teacher who, up until now, has paid PAYE; my husband does not work and he claims no benefits. In December, we bought the cottage adjoining ours, increasing our mortgage. My husband spent the first part of this year renovating the cottage, which was derelict, and he began to rent it in April. He sees to the renting, pays the increase in mortgage out of rent and keeps the remainder. My question is, should I have declared this income on my income tax return? Or should my husband apply for forms and declare this income entirely separately? Which is the most advantageous?

Maggie Fleming writes:

You do not have a choice in the matter. If the cottage is owned jointly, you will each be taxed on 50 per cent of the income for this tax year.

The only exception is if the lettings fall into the Revenue's definition of "furnished holiday lettings", in which case it will be treated as a business and the profit assessed on the person running the business – your husband. However, to qualify for this treatment, the lettings must meet a number of conditions, one of which is that the cottage must not normally be occupied for more than 31 days by the same person for at least seven months of the year.

If you own the cottage as tenants-in-common, rather than joint tenants, you could alter the way the property is split between you and make a declaration on Form 17 that the property is owned 99 per cent by your husband, in which case 99 per cent of the income would be taxed on him. But the declaration must reflect the reality of the capital shares you own and will only take effect from the date of the declaration. Alternatively, you could gift your share to your husband outright.

I am assuming there was no income in the year ending April 5 2003 but if there was, you have 12 months to amend your tax return. If your husband has a tax liability, his return is due today - he could download one from the Inland Revenue's website (inlandrevenue.gov.uk). Most importantly, you should take your cheque for any tax due to a tax office today, so you cannot be charged penalties or interest.