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

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I would like to run a bed-and-breakfast from our four-bedroom house. We hope to offer three bedrooms, all with en-suite or private facilities. Planning permission will not be a problem, but I am concerned about two things. First, will we attract business rates? Secondly, when we eventually come to sell the property, as it will technically be a business property, will we be subject to capital gains tax (CGT)?

Maggie Fleming writes: It is likely that you will attract business rates. Not all b&bs do - those that do not provide accommodation for more than six people at a time and those where the b&b is subsidiary to the private use will continue to be subject to council tax. However, if half or more of the property is used for guests at any time, or if you have installed extra washbasins, en-suite facilities or additional fire precautions, the property is likely to be rated. The council would also look at factors such as whether you are open all year round, offer evening meals or have a licence. From what you have said of your plans, you are likely to be rated.

Regarding CGT, there is likely to be a charge when you sell the property, based on the extent of its use for business and the duration of the business. You would not lose your private residence relief for the years you occupied the house solely as a residence, or for the final three years, but relief for the years in which the property is used as a b&b would be restricted to take account of that use.

On the plus side, you would benefit from the extended relief where a person lets their home as residential accommodation. This valuable relief exempts up to £40,000 of an otherwise chargeable gain per person. Assuming that you and your spouse own the house jointly, this could reduce any gain on sale by up to £80,000.

Presently, I take income from buy-to-let properties which are owned jointly by myself and my son. In August 2003 I became eligible for a state pension and in the near future I will also start receiving a small personal one. My wife makes very little use of her personal tax allowance and therefore it would be more effective to transfer the bulk of the income from the flats to her.

What is the simplest way to carry this out which will satisfy the Inland Revenue? I calculate that to balance our incomes my wife would need to be responsible for about 70 per cent of the flats' annual net profit of £6,000.

Maggie Fleming writes:

You cannot simply transfer income to your wife - you have to transfer the ownership of the underlying assets. There are special provisions for husband and wife which mean that you can transfer your share of the buy-to-let properties to your wife without incurring a capital gains tax (CGT) charge. It must be a gift, with no strings attached. A solicitor can do this for you easily.

However, it is likely to be to your advantage to transfer only part of your interest to your wife so that, when you sell any of the properties, you will be able to set both your and her personal exemptions against the resulting capital gain. You will also both be able to set any unused portion of your lower and basic rate bands against the gains.

Because of these CGT issues, I would advocate that you gift half of your interest to your wife so that you each own 25 per cent of the properties while your son owns 50 per cent. It would not be possible for your son to transfer an interest to his mother without triggering a CGT charge (unless the gain on the portion transferred were within the personal exemption - currently £8,200). If he is married, he could, of course, transfer part of his share to his wife to obtain the same tax advantages.

I hear many of my contemporaries saying they are protecting their children's inheritance by placing their property in a discretionary trust. What is different about this from any other form of trust and how does it avoid inheritance tax (IHT)?

From my understanding, which is far from clear, it prompts a number of questions. If you set up a discretionary trust can you later dismantle it? Could one's children ask for rent from their portion of the trust whilst you are living in it? Also, has the Chancellor in his last budget decided to charge the parents income tax on half the property as a benefit in kind?

Maggie Fleming writes:

I assume that you are using the word "property" to mean "the family home", rather than the wider definition of "belongings". If that is so, this option is no longer available. For some years, advisers have marketed sophisticated and expensive schemes, often involving two trusts, which meant that, under the law as it stood, a person could effectively remove the family home from their estate while continuing to live in it.

Despite the fact that these schemes were made much less attractive by the imposition of Stamp Duty Land Tax last year, and would have probably withered on the vine for that reason, the Chancellor, in his March budget, delivered the kiss of death. The relevant proposals are at Schedule 15 of the Finance Bill. If enacted, the legislation will be retrospective, imposing an income tax charge on anyone who has implemented this type of scheme at any time since March 1986. The charge will take effect in April 2005 and will be based on the market rental of the property.

In the same budget, the Chancellor announced measures that will make discretionary trusts less attractive from a tax point of view. They will still play an important role in estate planning for wealthier people, however, because of their flexibility in adjusting to changing family circumstances and the discretion which the trustees enjoy in making payments to beneficiaries. This is a complex subject and, if you feel that a trust may benefit your family, you should consult a solicitor.

Some 25 years ago we bought a small house for my parents and they lived there happily before moving into sheltered accommodation. The house is 50 years old and it will be expensive to bring it up to modern standards. Given that the plot has excellent, unrestricted sea views, it may be more sensible to demolish the house and build a new one which would maximise the location and where we might live. Given that we have never lived in the present house, we accept that there will be a capital gains tax (CGT) liability but could you advise how and when this would be charged if we were to demolish and rebuild?

Maggie Fleming writes:

You may be wrong in thinking that you are liable to CGT. As your parents were living in the property before April 6 1988, the gain may be exempt by virtue of dependent relative relief.

In order to qualify, various conditions must be met - your parents must have been aged 65 or over before April 1988 or unable to support themselves because of illness or disability. They must also have been living in the house substantially rent-free, although there would be no problem if they were paying their own council tax and footing the bill for normal repairs. If you qualify for the relief, the gain is exempt, just as though you had lived in the property yourselves for the past 25 years.

If you decide to pull down the old house and build a new one, I suggest that you seek professional advice. You are proposing to demolish the qualifying residence but may be able to claim dependent relative relief on the demolition of the old property - under the CGT legislation, destruction of an asset can be treated as a disposal, triggering any relief due. If you lived in the new property as your only or main residence, it too would qualify for relief. It is a complex situation, however, and you should ask a specialist to review it in full.

When my son started going steady with his girlfriend two years ago, they agreed that her name would be added to the ownership documents for his house. They also increased the mortgage on the property in order to repay several loans on high interest-rate accounts, and decided that she would become jointly responsible for paying it.

Two years later, unfortunately, they are breaking up. Having agreed a fair separation of their money and assets, they want to have her name removed from the mortgage and ownership documents. However, their solicitor has said this counts as a sale of half of the house, despite the fact that no money is changing hands, and is therefore subject to Stamp Duty. This will cost them approximately £1,400.

Surely they cannot be charged this sort of money for what amounts to a two-minute amendment to the records at the Land Registry?

Maggie Fleming writes:

This is a transfer of equity as your son is assuming responsibility for his ex-girlfriend's share of the debt in order to purchase her half of the property. Their solicitor is therefore correct in advising that Stamp Duty Land Tax is due on the transaction.

As no money is changing hands, the consideration for the transfer will simply be the value of the half of the debt which he is assuming. If he were paying an additional sum to buy her out, that would be added to the consideration also. If the consideration is less than £60,000, it will be charged at 0 per cent. From £60,001 up to £250,000, it is charged at 1 per cent, which is the rate applying in this instance. Above £250,000, higher rates apply.

This case illustrates how one should think carefully and take legal advice before entering into these kinds of transactions, especially where property is involved. Your son will think twice before he puts a new partner's name on the deeds. As well as Stamp Duty considerations, there could be (depending on how matters are arranged) other tax and legal considerations and it is wise never to enter into such arrangements lightly or without seeking professional advice.