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 January 2005. Older articles are accessed through our main Property Tax page.

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My 84-year-old mother has a house which she bought in 1964 and from which she has been receiving rent ever since. She has never occupied it, as she has been living with my sister. She has now divided the house into two flats, one of which has been sold for £160,000, and the other continues to provide rent. As she does not own another property, can she nominate the flat or the whole house as her primary residence and avoid Capital Gains Tax (CGT), and is there a time limit?

Maggie Fleming writes:

No – the property cannot qualify as your mother's principal private residence. The fundamental condition for the relief is that the qualifying property must at some point during your period of ownership have been your residence. If you have two residences, you can, within two years of acquiring the second property, nominate one of them as your principal private residence – but you must actually have resided in both.

The only exception to the rule that you must have lived in the property is where you live in job-related accommodation but have bought a property to retire to. If you later change your mind and sell it instead, you should still qualify for the relief, even though you never occupied it, provided that you can show that your original intention was to live there.

How does it work?

One of the best ways of reducing your estate's exposure to IHT is by a programme of regular gifting. Each individual can make gifts of up to £3,000 pa. If you do not make a gift in any given year, the exemption can be carried forward – for one year only – and aggregated with the following year's exemption.

Are there other ways of minimising my contributions?

There are also exemptions for gifts in consideration of marriage; gifts of no more than £250 to any one person and gifts that can be shown to be regular normal expenditure out of income. You can also make unlimited gifts to individuals and non-discretionary trusts – these are Pets (Potentially Exempt Transfers) and fall out of your estate, provided that you live for seven years after making the gift.

Seems pretty straightforward

It sounds simple but there are practical problems. The main one, of course, is that while gifting income-producing assets to your children will reduce your estate's IHT bill, you may not have left yourself enough to live on.

Yikes!

Another difficulty is that the gift of anything other than cash – shares or an investment property, for example – may also give rise to a Capital Gains Tax (CGT) charge. It may be better to keep assets which are pregnant with gains, as there is no CGT on death. The best assets to gift are those which are likely to appreciate greatly in value over the years.

Anything else I should know?

It is not effective for IHT to gift an asset which you continue to enjoy, as this is a "gift with reservation of benefit" and remains in your estate. In the past few years, many ingenious schemes were marketed that were thought to circumvent the rules by enabling people to gift their homes while remaining resident in them. The Government has put a stop to these schemes with the pre-owned assets legislation which will come into effect in April. The legislation will affect any such gift made since March 1986.

We are currently renting and, like many others, are unable to afford to buy the house we want in the current climate of high property prices in the South-East.

In an attempt to get on the property ladder, we are considering purchasing a house in France (while still living and working in England) to modernise and resell in an attempt to build up more capital. If we were to do this in England, we would not have to pay Capital Gains Tax (CGT) on any profit as it would be our main dwelling. What would be the situation if we bought in France and could provide the authorities there of evidence that we were not homeowners in Britain?

Maggie Fleming writes:

I am not an expert on French CGT and suggest that you consult a French tax adviser. I understand, however, that the main residence exemption will only apply if you are a French resident and this may therefore be of no use to you. However, the conditions for the exemption have been relaxed recently, so if you have lived in a property and been tax resident in France for at least two years at some point during your period of ownership, the whole gain is exempted, even if you are not resident in France at the time of sale.

There have been other recent changes to the French CGT regime which make owning property in France more attractive for United Kingdom residents. The CGT rate is only 16 per cent of the net gain and 10 per cent is knocked off the gain for every year of ownership after the fifth, so there is no tax at all to pay after 15 years.

You should also give thought to your UK tax position. On the assumption that you will spend time in the French property and that it can properly be considered a residence of yours, you should elect for it to be treated as your main residence for UK purposes. You should do this by writing to your tax district within two years of buying the French property. Odd though it may seem, failure to do this could result in you having to pay UK CGT on sale of the property, less a deduction for the French tax suffered.

If you are unmarried, you should seek specialist advice on French succession laws.

My husband and I jointly own a buy-to-let property and are considering selling the property to finance school fees for our 10-year-old twin sons. If we put the property in trust for the boys to be used for educational purposes, would we/they incur Capital Gains Tax (CGT) or any other tax?

Maggie Fleming writes:

Trusts are a very complex subject and the Government seems determined to remove all the previous tax advantages associated with them. For example, income and gains are now taxed at 40 per cent – the same as for a higher-rate taxpayer – and further changes are planned.

The type of trust usually favoured for the benefit of minor children is an "accumulation and maintenance" trust. However, a gift by you of the property into such a trust would not be exempt from CGT and you and your husband would be taxed normally on the gain. For inheritance tax (IHT) purposes, the gift would be a Potentially Exempt Transfer (PET) and the value of the property would fall out of your estates after seven years. You would also be taxed on the income of the trust while your children are minors.

Given that the cost of setting up an A&M trust is in the region of £1,000 and the annual administration costs would be £500, you may feel that it is not worthwhile.

There are other kinds of trust. A discretionary trust would enable you to hold over the gain on gifting the property into trust but the gain would become chargeable on the trustees when it is sold, so this would only be advantageous if you were keeping the property. Furthermore, discretionary trusts involve IHT charges every 10 years and when capital leaves the trust.

We are looking to convert our nearby barn into a home for my 83-year-old mother-in-law. To finance this, we are extending our mortgage and what my mother-in-law proposes is to sell her house and divide the proceeds between my husband and her other son.

We shall use our share to pay off the loan for the barn. How do we stand with regard to Inheritance Tax (IHT) and/or Capital Gains Tax (CGT), bearing in mind that we will eventually sell our property either as a whole or as two separate dwellings?

Maggie Fleming writes:

It used to be possible for parents to circumvent the IHT "gift with reservation of benefit" rules by selling their house and giving the proceeds to the children, who would then use the cash to purchase a replacement home for the parent. The reservation of benefit rules would not apply and the only IHT consequence was that the cash gift was a Potentially Exempt Transfer (PET) and could give rise to an IHT charge if the parent died within seven years of making the gift.

Recent legislative changes have made this impossible. What you propose is likely to fall foul of the new pre-owned assets legislation and your mother-in-law could face an annual income tax charge, based on the rental value of the barn, from April 2005.

As for CGT, many cases have been fought over the issue of what exactly constitutes a residence. If your mother-in-law were moving into an annexe to your home (a "granny flat"), there would be no problem – the flat would be treated as part of your main residence and attract principal private residence relief on sale. But the taxman would take the view that the converted barn is a separate dwelling house, not attracting the relief when you sell it. Some relief might be available if, after your mother-in-law's death, you were to use the barn as an integral part of your home.