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

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Four years ago my son bought as his private residence a freehold property which was registered in his sole name.

The purchase price of £75,000 was met by my son using £25,000 of his own money, with the balance of £50,000 being covered by an interest-free loan from me, secured by a legal mortgage on the property.

The property is now worth about £100,000 and because of a change in financial circumstances, my son has suggested that I should acquire an interest in it, in return for cancelling the legal mortgage, so that I can share in any future increase in its value.

Can you advise me if I am correct in assuming that, as I am in effect investing £50,000 in a property currently valued at £100,000, there would be no liability to Stamp Duty Land Tax in my acquiring part-ownership as the transfer value is less than £60,000?

Also, would my future Capital Gains Tax (CGT) liability be based on 50 per cent of any proceeds above £100,000?

Maggie Fleming writes:

You state that this plan is being considered because of a change in your financial circumstances and therefore there may be compelling reasons for implementing it which have nothing to do with tax.

From a tax point of view, however, it would be better if you could achieve your objectives without becoming a co-owner of this property.

The reason is that, while the property is owned 100 per cent by your son and he continues to live in it, any gain on eventual sale is entirely sheltered from CGT by principal private residence relief.

Once you acquire an interest, however, your half of the property becomes potentially liable to CGT. I suggest that you seek professional advice – it may be possible to arrange your affairs differently.

If you proceed with this plan, you are correct in thinking that there is no Stamp Duty Land Tax to pay. The other tax to consider is Inheritance Tax (IHT). If you were to die now, the money you lent your son (less any repayments of capital) would be included in your chargeable estate.

If you die after acquiring an interest in the property, it would be the value of your interest at death that would be included in your estate – likely to be a larger figure. If your total estate is more than the nil rate band, this will increase your estate's liability to IHT

My main property is in the South-East and I have a second home in the West Country. In a few years' time we intend to sell up and move to the West Country, although not to our current second home, which would also be sold. We know that this would be subject to Capital Gains Tax (CGT).

One option is to sell up in the South-East and move to our second home while we looked for a new house. Would the second property become our main residence such that there would be no liability for CGT on it?

Maggie Fleming writes:

This is a question I am often asked. The legislation states that the relief is available on any gain arising on the disposal of a dwelling house that has at any time during his period of ownership been the taxpayer's only or main residence. As you would be living in the property and it would be your only residence at that time, it seems on the face of it that you would qualify for the relief for the final 36 months of ownership, although not for earlier.

However, if a considerable amount of tax were at stake, the Inland Revenue could argue that the word "residence" implies a degree of permanence and that you are simply using the place as temporary accommodation. While this distinction does not feature in the statute, the courts have supported the Revenue's view on this point.

People often ask if there is a minimum time they have to live in a property in order to be able to claim principal private residence relief. There is not. A short stay in a house that you intended to make your permanent home will qualify, while a longer stay in a property you always considered a temporary home may not. It is the intention that matters – and intention is notoriously hard to prove or disprove.

We purchased a two-bedroom flat two years ago as our main home but at the same time bought a bedsit in the basement for £59,500. We intend to join the two properties together.

The bedsit is now worth £130,000 but the estate agent informs us that the two properties joined together would sell for less than if separately sold, so basically we would be devaluing the properties. What are the implications of Capital Gains Tax (CGT) on our plan, please?

Maggie Fleming writes:

I assume that the bedsit is directly below your flat and that you will make any modifications necessary to turn the two properties into a single dwelling (eg installing internal doors etc).

If that is the case, the two properties will be accepted as a single dwelling, forming your only or main residence when you eventually sell the property. This would mean that the enlarged property would be exempt from CGT from the date when they are joined together.

You do not say what the bedsit has been used for up to now. If it has been let out, principal private residence exemption would not be due for that period and part of the gain would not be exempt.

However, if you have, in fact, been using the bedsit as an extension of your flat since you bought it, the Inland Revenue is likely to accept that it has been part of your main residence since purchase. In that case, the whole gain would be exempt on sale.

The same treatment applies to extensions to the family home and also to "granny flats" where elderly relatives move into a basement flat or purpose-built annexe. Provided there is internal communication between the two previously separate entities, there should be no problems with CGT.

I know Stamp Duty is going to cost me money when I buy a house but what is it for?

Basically, it is a tax. Stamp Duty has been around in one form or another since the end of the 17th century, which makes it even older than income tax. Like income tax, it was originally intended as a temporary measure. However, governments got rather fond of the steady stream of revenue provided by house sales, so it stayed.

Ah, but unlike most taxes, isn't there a way of avoiding this one?

There was but that all changed at the end of last year when the government introduced Stamp Duty Land Tax (SDLT) for property transactions. Before that Stamp Duty was a tax on instruments (documents) rather than transactions and it was possible to avoid it by leaving a document unstamped. Now that the tax is transaction-based, that loophole has been closed.

So what are the actual mechanics of the tax? Who pays and is it just based on a flat rate?

No, it works on a sliding scale. The buyer pays any SDLT due. There is no tax to pay where the purchase price of a residential property is £60,000 or less. Up to £250,000, the rate is 1 per cent of the purchase price. Between £250,001 and £500,000, the rate is 3 per cent and, for properties costing more than half a million, it rises to the top rate of 4 per cent. Different rates apply for non-residential properties.

When do I have to bite the bullet and pay the thing?

Documents are no longer "stamped". Instead, the buyer completes a Land Transaction return and sends this to the Inland Revenue, together with a cheque for the SDLT due. The Revenue then issues a certificate which enables the Land Registry to register the property in your name. Penalties and interest will apply if the return is not filed and the tax not paid within 30 days of completion.

This could be expensive. Please tell me some way to ease the pain.

The tax only applies to the cost of the land and any fixtures and fittings, such as fitted kitchens or bathrooms. If the purchase price includes an amount for moveable items, such as furniture, carpets and curtains, this is not liable to SDLT. However, the Revenue will expect the apportionment of the purchase price between taxable and non-taxable items to be fair, and they can check returns for their accuracy.

In calculating the profit for Capital Gains Tax (CGT) purposes:

1) Do I use the quoted value of the property when I bought it or the price I paid for it after the RTB discount?

2) Can I use any of the time I lived in the property as my main home to reduce CGT by way of taper relief?

Maggie Fleming writes:

The acquisition cost to be used in the CGT calculation is the actual cost paid by you, after the RTB discount, not the market value of the property at the time. Unfortunately, this will increase your gain and thus the tax payable.

There are various exemptions available to you, however. Your period of ownership is now in excess of six years. Of that period, 39 months will be exempt by virtue of principal private residence relief – the three months when you lived there plus the last 36 months of ownership, which are always exempt. That's half the gain exempted.

Furthermore, as you were letting the property out as residential accommodation, much of the gain attributable to the remaining 37 or so months is also likely to be exempt. The amount of this exemption will be the lowest of three figures – the gain already exempt under principal private residence relief, the gain attributable to the period when it was let out and £40,000. So, an additional amount of up to £40,000 may be exempted by this relief.

Only years when you actually owned the property count towards taper relief, so the years before 1998 are irrelevant. However, as you have owned the property for six complete years, only 80 per cent of the gain will be chargeable if you sell the flat now. Also, if you are married, you could gift a half interest to your spouse and make use of two personal exemptions (currently £8,200 per person) and possibly a lower tax rate.