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

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I purchased a house in November 2001 for £396,000. The purchase was to give my two sons a home to share as, in our part of the country, it was not possible for them to buy or rent a property on their salaries. They have lived in the house since and I have not received any money from them to offset the mortgage.

Now they are earning reasonable money, I intend that they take a share in the property, although they cannot afford the full price. I understand that the sale of the property to my sons will incur Capital Gains Tax (CGT) on the difference between what I paid and its current market value, some £160,000. What CGT liability will I incur if my sons were to take, say, 50 per cent ownership of the house immediately and increase their stake when they can afford it?

Maggie Fleming writes:

A sale or even an outright gift to your children will always be treated as taking place at market value. On your figures, a sale of 50 per cent to them is likely to result in a chargeable gain of £80,000. You will be entitled to the usual reliefs - taper relief (currently 5 per cent but increasing by 5 per cent for each additional year of ownership up to a maximum of 40 per cent after 10 years), relief for major capital expenditure and for the incidental costs of purchase (Stamp Duty, legal and estate agents' fees).

In the long run, it will be better for your sons to own as much as possible of the property, as the house is their home and therefore their period of ownership will attract the CGT principal private residence exemption. However, you will want to shoulder as little of the tax burden as possible. One way of mitigating the liability would be to make annual sales or gifts of a small percentage of the property. If you are married, you could gift half the property to your spouse and each of you could make annual gifts to your sons - in this way you would each make full use of your annual CGT exemption - this is £8,200 for 2004/05 but increases at least by inflation each year.

My husband and I sold our house in Leicester in August and moved to live with my mother-in-law who was recently widowed. My husband has inherited from his late father the basic tax-relief sum, which is tied up in his mother's property, approximately to the value of one quarter of the house. The other three-quarters of the property is owned by my husband's mother.

What do we need to do to prove that this is our primary home? We contribute to the bills, but the council tax demand is in the name of his mother, as are all the other bills.

His mother is also thinking of transferring another quarter of the house to my husband; does that mean we will be unable to buy a house of our own or a second property within the next year without incurring another tax bill?

My mother-in-law is also thinking of selling the house next year, so if my husband owns half the house is he liable to Capital Gains Tax (CGT) on the sale? His mother does not want to hand over half the money from the sale to my husband until she is deceased. What is the best course of action?

Maggie Fleming writes:

Provided that you are living in the property, and so long as you own only one property, the Inland Revenue is unlikely to ask for proof of residence.

You could make sure, however, by ensuring that this is the address used on your tax returns or any other correspondence with the Revenue. You could also have yourselves put on the electoral register at this address and register with a local doctor.

If you purchase another residence, you will have two years in which to make an election, choosing one or the other as your main residence for the purposes of the CGT principal private residence exemption. It is possible to manipulate the timing of these elections to ensure that minimal tax is paid on sale of either residence. You will need to discuss this matter with a tax practitioner, however.

If you and your husband have been living in the property at any point in the three years before sale, there will be no CGT to pay on sale, because of the PPR exemption.

From a CGT point of view, this arrangement is fine. It is also excellent from an Inheritance Tax (IHT) perspective. Home-sharing arrangements of this kind, where a parent gifts a share of the family home to the children living with him or her, is one particular type of estate planning that is not affected by the pre-owned assets legislation.

It is also excellent planning for your mother-in-law to gift a further 25 per cent interest to your husband, as this reduces her estate. She might even be able to gift a larger share (although the Revenue might want to question it) - again, seek specialist advice.

When my grandmother made her will in 1980 she left her house to me in trust. My mother was to live there rent free for her lifetime and the house could not be sold without my mother’s consent in writing. After my grandmother’s death the deeds of the house were put into my name and that of the solicitor as the joint trustee. My parents continue to live in the house.

Can you advise me on the question of inheritance tax when my mother dies? As the house is already in my name would I be liable for inheritance tax (IHT) on the property?

Maggie Fleming writes:

This sounds like a simple ‘interest in possession’ trust – your mother is the ‘life tenant’ with the right to live in the house for her lifetime. On her death, the property will pass absolutely to you. For IHT purposes, your mother is treated as though she owned the property.

So, on her death, the market value of the house at that time will be added to her other assets and, if the whole exceeds the nil rate band (£263,000 for 2004/05), IHT will be payable on the excess at 40pc.

But while your mother’s estate would bear the burden of the tax on her other assets, the trustees would be responsible for the tax on that part of the estate attributable to the house. On a more positive note, for Capital Gains Tax (CGT) purposes, the house will be treated as having been disposed of and reacquired by the trustees at market value at the time of your mother’s death – this will also be the probate value.

This probate value will be treated as your acquisition cost when you sell the property. As this is likely to be higher than the value when your grandmother died, there will have been a free uplift in value, with no CGT to pay on your mother’s death.

My wife and I bought a two-bedroom semi-detached house for our daughter and granddaughter in June 1997. Our daughter is a single parent and they had previously been living in various rented flats, most of which left much to be desired.

We paid £48,500 plus legal fees, etc for the property, and have since spent £9,370 on essential repairs for the house. It is held in my wife's name for income tax purposes and is let to our daughter on an assured shorthold tenancy for a furnished dwelling house. She has been paying rent at a full commercial rate and this has been declared to the Inland Revenue.

Our daughter is now becoming financially self-sufficient, so we intend to gift the house to her, and this would be noted in our wills, as we have three other children. I realise that after seven years this asset will drop out of my wife's estate for Inheritance Tax (IHT) purposes, but could there be a Capital Gains Tax (CGT) liability, even though there would be no gain to my wife? The property is now worth approximately £120,000.

Maggie Fleming writes:

When people think of gifting property, they usually consider the IHT consequences but all too often overlook the fact that CGT is chargeable on most gifts also.

Even though your wife would not receive any money from your daughter, there would be a chargeable gain based on the difference between its market value at the date of the gift (approximately £120,000) and its base cost. The base cost would be the acquisition cost of £48,500 plus any of the £9,370 "repairs" that were of a capital nature, are still apparent in the state of the property and have not already been claimed as deductions from rental income in your wife's annual tax returns.

The gain would be reduced by a small amount of indexation allowance on the acquisition cost and any eligible enhancement expenditure. If the gift is made in the current tax year, taper relief would mean that only 75 per cent of the gain would be chargeable. If the gift is made after April 5, the chargeable portion would be 70 per cent. Finally, your wife could set her annual exemption (£8,200 for the current year) against the gain.

However, you may be able to reduce the gain considerably if your wife gifts a half share of the property to you before you both gift the property on to your daughter. By doing this, you will each be able to make use of your annual CGT exemption. You should seek advice from a tax practitioner who can calculate any saving, taking account of your and your wife's other income and marginal tax rates.