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 October 2002. Older articles are accessed through our main Property Tax page.

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Isis Financial Planners offers tax planning advice as well as a Tax Self Assessment Service.

A friend who is resident in the UK unfortunately has advanced cancer. He is keen to free up the equity tied up in his house in order to enable him to enjoy the remainder of his life. I am considering buying the house and letting him stay there until such time as he dies. Is there a suitable structure that can be set up to cover such a situation? Important questions include should he pay me rent and would I have to pay Capital Gains Tax (CGT) when the house is sold after his death?

The house is currently worth approximately £150,000. Although I was born in the UK, I have not been resident in this country since 1971 and now hold an Australian passport. I have no other property in the UK.

Maggie Fleming writes:

A straightforward sale of the property from him to you is feasible. Provided you remain not resident and not ordinarily resident in the UK, you will not be chargeable to Capital Gains Tax (CGT) in the year in which you sell the property. Nor will your friend be liable to the tax on sale of the house to you, if it has been his only or main residence throughout his period of ownership.

If he pays you rent, there may be administrative complications, as you are likely to fall within the special provisions for non-resident landlords, unless the rent is low. Either your friend will have to deduct tax and pay it over to the Inland Revenue before sending you the balance of the rent, or you will have to obtain approval from the Revenue for rents to be paid to you gross.

Depending on the facts, you may have to complete an annual UK tax return, entailing effort and expense. If it is not a financial burden on you, you may prefer to allow your friend to live in the property rent-free.

Before taking any action, you should check with an Australian tax adviser that there are no adverse tax consequences in that country.

I am the survivor of a homosexual relationship of 50 years. Property owned jointly consists of a large house in west London, partly our home and partly let in furnished flats, and a cottage in Somerset, part of which is let. In addition, I am the sole owner of a tenanted house, the income from which has sometimes been paid into our joint account, as distinct from my personal account. Now, I am beginning to complete an application for grant of probate, and the inheritance tax (IHT) potential of my late partner's estate is causing me great anxiety. If I raise a mortgage on any of the properties to pay the tax, would the mortgage interest be deductible from rental income? I understand that the properties will be valued as at the time of his death - would the valuation be at "vacant possession" value? Is it true that there is no Capital Gains Tax (Capital Gains Tax (CGT)) payable on the property of a deceased estate? The law does seem to bear harshly not only on gays but also on heterosexual couples who for one reason or another cannot marry.

Maggie Fleming writes:

I am very sorry to hear of your loss. Unfortunately, the current Inheritance Tax (IHT) law recognises only married couples. Had you and your partner been married, you would not have a penny of tax to pay. As it is, with property prices at their current levels, the estate is likely to have a substantial liability.

I assume that the properties you owned jointly were held as joint tenants, rather than as tenants in common. The properties will pass to you automatically by survivorship but the open market value of your partner's share at the date of his death will be liable to Inheritance Tax (IHT) at 40 per cent. The valuation is not on a "vacant possession" basis but will take account of tenancies and will also be discounted to take account of joint ownership.
There is no Capital Gains Tax (CGT) liability on death - your acquisition cost for Capital Gains Tax (CGT) purposes will be the probate value.

There is provision for interest relief on a loan to fund Inheritance Tax (IHT) but this is restrictive and applies for only one year. It may be possible to mortgage one of the rental properties (up to its acquisition cost) and claim interest against rents if a case can be made that this is for the purposes of the business - seek professional guidance on this.
Clearly, current Inheritance Tax (IHT) legislation discriminates against same-sex and unmarried couples. Although too late for you, you may be interested to know that Stonewall (020 7881 9440), among others, is lobbying actively to have these outdated and unfair laws changed.

When my wife died, shortly after our divorce 20 years ago, her half-share of our property passed to our children but under a Deed of Family Arrangement I continued to live in and maintain the house. Am I correct in assuming that, on my death, half the value of the property already owned by the children will not count towards Inheritance Tax (IHT) on my estate?

Maggie Fleming writes:

It depends on the exact terms of the deed. Deeds of Family Arrangement (also known as Deeds of Variation) are often used to "rewrite" the will and make it more tax-efficient. For Inheritance Tax (IHT) purposes, the changes made by the deed are treated as though they formed part of the original will. Although your wife left her half share of the property to the children, the effect of the deed may be that they have given up their interest and ownership has passed to you. If that is the case, 100 per cent of the property will fall into your estate on death.

Alternatively, it is possible that the deed has put a trust in place, so that you enjoy a life interest in your late wife's share of the property but, on your death, it passes to your children absolutely. If that is the case, your wife's half share would still fall into your estate on death - a person with a life interest in trust property is treated on death as if he were beneficially entitled to the property itself - although responsibility for paying the tax would lie with the trustees.

You need to ascertain the exact position and find out how the deed has varied your wife's original disposition. I suggest that you take a copy of the deed to a solicitor for detailed advice.

I bought a house for the use of my children while at university. It is registered in joint names to me and my wife, and is a second house. My son would now like to buy the house but cannot afford the market price. Can I sell it to him at a price he can afford, or does this cause tax problems? What is the situation if I give it to him?

Maggie Fleming writes:

It does not make any difference for Capital Gains Tax (CGT) purposes whether you sell it to him at a reduced price or give it to him - as you and your son are "connected persons", all transactions between you are deemed to take place at market value. So you and your wife will each be taxed on 50 per cent of the difference between the property's current market value and the price you originally paid for it.

You will each have the benefit of the annual exemption (currently £7,700), indexation relief (if the property was owned prior to April 1998) and taper relief (if you have owned it for at least three years). You can also deduct the incidental costs of purchase and sale - estate agents' and legal fees - and certain capital expenditure.

In many cases, these reliefs and deductions are enough to extinguish any gain. If not, you may think about selling him the property in stages over several years, with you and your wife using up your exemptions each year. The property in your son's hands will be free of Capital Gains Tax (CGT) on a subsequent sale to a third party, provided it is his only or main residence.

From an Inheritance Tax (IHT) point of view, a gift or sale at undervalue will be a Potentially Exempt Transfer. It will reduce your estate and no Inheritance Tax (IHT) is payable provided you live for seven years after making the gift.

I am currently working and living in Barbados. I have a small flat in Scotland (£80,000) and I intend to keep this flat as it is on a golf course that I love. I am, however, looking to buy a second property (£150,000), which I will then rent while I am living abroad. Will this present any tax problems? Should I not be so sentimental and just have a single, more expensive property?

Maggie Fleming writes:

It depends on your circumstances and future plans. How long have you been out of the UK and when do you plan to return? What do you plan to do with the second property when you return to the UK? If you purchase the new property and let it out, the income (less expenses) will be taxable in the UK, although you can set your personal allowance against this. There are special arrangements for non-resident landlords - tax will be deducted by your agent unless you register for the Non-Resident Landlords Scheme.

On the assumption that the Scottish flat was your main residence prior to leaving the UK, and that you have not bought a property in Barbados, it may be tax-efficient to buy the property you mention as an investment and sell it while you are still non-resident, before the tax year in which you return to the UK. There would be no Capital Gains Tax (CGT) liability in those circumstances.

Furthermore, by resuming residence in your Scottish flat on your return to the UK, you would be entitled to Capital Gains Tax (CGT) private residence relief for your period abroad.
This is a complex issue, however, and I am not in possession of all the relevant information. I recommend that you seek professional assistance, for both the UK and Barbadian tax consequences of any proposed action.