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

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I have been granted planning permission to build a second house in my garden. I suspect, possibly incorrectly, that if I sell it either as a building plot or a fully developed house I will have to pay a substantial amount of Capital Gains Tax (CGT). However, I could sell my current house and move into the newly-built property and occupy it for at least the minimum period for it to be classed as my main residence. Would this avoid incurring CGT on the sale of the new house?

I have also been informed that there is a plot-size below which CGT does not apply if sold for redevelopment. Is this correct and if so, what are the size limitations involved?

Maggie Fleming writes:

It is a common misconception that there is a "minimum period" for living in a property which enables it to be considered your principal private residence. This is incorrect. What matters is your intention, not the length of time you live there. If you build a house and move into it with the express intention of selling it on at a gain as quickly as possible, you will not qualify for the tax exemption. If sold on quickly, HM Revenue and Customs would be likely to query the transaction. There is CGT avoidance legislation in this area. Or, alternatively, they could contend that such a sale, even though isolated, showed that you were carrying on a trade as a property developer and tax the profit to income tax without any of the usual CGT exemptions (such as the annual exempt amount of £8,500).

However, if you sell part of your garden to developers, and the total area of your house and garden does not exceed half a hectare (approximately 1.23 acres), the gain on the sale is covered by the principal private residence exemption. If your house and garden occupy more than half a hectare, the position is more complicated and at least part of the gain could become chargeable to CGT. If you are married, you could mitigate these effects by giving a share of the property to your spouse prior to sale.

Incidentally, the Government is floating the idea of a new tax on windfall development gains. The tax could well be levied at the point where planning permission is granted. More information is likely to feature in the pre-Budget report.

My partner bought a house in 1990 for approximately £40,000. He lived there for seven years and then bought a flat, which he moved into immediately and sold six years later, making a profit of £48,000. After selling the flat, he moved back to his house, which had been rented out in the meantime, and has been living there for the past two years.

I am worried about Capital Gains Tax (CGT). Should he have paid CGT on the sale of his flat? What will the Inland Revenue do if he comes clean about it now? And will he have CGT to pay if he sells his house now? It is now worth about £100,000.

Maggie Fleming writes:

Your partner has nothing to worry about. I'll deal with the flat first. As the flat was his main residence throughout his entire period of ownership, the gain of £48,000 is completely exempt.

The house is slightly more complicated. If he sells it now, he will have owned it for a total of 15 years. In that time, he has lived in it as his only residence for periods totalling nine years. Therefore, 9/15ths of the gain is exempt for that reason. But, in addition to periods of actual occupation, the final three years of ownership are always exempt also. There is an overlap in this case, as two of the final three years are periods of actual occupation but a further one year would be allowed. Therefore a total of 10/15ths, or two thirds of the gain is exempt. Furthermore, the gain is reduced by indexation allowance and taper relief.

But, crucially, the remaining one third of the gain will also be exempt, as the house was let out as residential accommodation. Where a property which has ever been your only or main residence is let out in this way, the part of the gain that is attributable to the period of letting is also exempt, up to a maximum of £40,000, provided that it is not greater than the amount of principal private residence relief already due. In your partner's case, it will all be exempt.

My wife and I own two buy-to-let properties in joint names. Both were bought as investments and they have proved to be very successful. However, as I have now retired, we are considering selling one of these properties to enable us to have capital to pursue other interests.

The taper relief on Capital Gains Tax is much more generous if the gain is on "business assets" rather than "non-business assets". The description, in the booklet we have, of who qualifies for "business assets" is ambiguous, to say the least. Although we are not registered as a company, we nevertheless purchased the properties purely for investment and use an agent to let them. Would we therefore qualify for the taper relief under gains on "business assets"?

Maggie Fleming writes:

The property is unlikely to qualify for business-asset taper relief on sale. This is because HM Revenue and Customs does not normally regard property letting as a trade such as manufacturing or retailing. Therefore, it does not attract rollover relief, holdover relief or business-asset taper relief. On the whole, in the Revenue's eyes, owning let property falls somewhere between having an investment that produces an income and a "proper" trade. Using managing agents or operating the business via a company does not alter this.

There is one exception to this rule - furnished holiday lets. To qualify as a furnished holiday let, a property must be available for letting commercially for at least 140 days in the tax year and must actually be let for at least 70 days. In any seven-month period (which includes the 70 days of actual letting), it should not normally be let to the same person continuously for more than 31 days.

It is therefore unlikely that your property falls into this category, as most buy-to-let properties are rented on tenancies of more than 31 days. However, if a person can bring their rental property within the buy-to-let rules, the capital gains advantages are certainly worth having.

After they graduated, I helped my two eldest sons jointly purchase a flat in London by paying one third of the mortgage. For this the building society required me to be a joint owner and to have my name on the deeds.

I did not expect my sons to be able to live under the same roof for very long but seven years later neither of them wishes to move on. As they are now able to afford to meet the mortgage payments themselves, I now want to give them my share of the property and to cease my contribution.

However, I have been advised that if I go ahead with the plan, I will be liable for capital gains tax (CGT) on one third of the increase in the value of the property, which is about £180,000. Part of this rise is due to the £30,000 I spent on improvements when my sons first moved in.

Can you please tell me if this is correct, and if so could I avoid paying any CGT at all if I give my share of the flat to my wife in this tax year and then she gives this share to our sons in the next tax year?

Maggie Fleming writes:

While you cannot claim mortgage payments as a deduction for CGT purposes, you can claim the cost of any improvements or refurbishments which were of a capital nature and which are still apparent in the state of the property. So you may get relief for the cost of major improvements. You will also benefit from taper relief.

From the figures you have given, I assume that you are a higher rate taxpayer and that the entire gain would be taxable at 40 per cent. If your wife is either a non-taxpayer or a basic rate taxpayer, it will be beneficial to gift her a part of your interest in the property. That way you can make use of both your annual exemptions (currently £8,500 per person). If you give her your whole interest in the property, only one annual exempt amount, hers, will be used. Furthermore, as the gain is so large, your wife would be taxable at 40 per cent on some of it. So you may as well make use of both allowances. This would reduce the tax bill considerably.

Once you have arranged joint ownership with your wife, you do not have to wait until the following tax year to pass the property on to your sons - assuming that the property rises in value by more than the annual taper relief amount (5 per cent) and the increase in your and your wife's annual exemptions. Provided that everything is properly documented, HM Revenue and Customs will have no problems with this.