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

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I live in a flat in Kingston-upon-Thames which is probably to be sold for £400,000. I owned the flat and gave half to one son in 1999 when the property was valued at £300,000 to £350,000. The second half I gave to my other son in 2002 when it was valued at £425,000.

I am aware that the gifts were with reservation but I am moving out into sheltered accommodation. Does this mean that the reservation clause has been removed and if my sons sell now, will just Capital Gains Tax (CGT) apply?

Maggie Fleming writes:

The reservation will be removed when you cease to live in the property. For inheritance tax (IHT), the effect of this is that the gift will be treated as having taken place at the date the reservation is lifted.

It will be as though you gifted the property to your sons on the date you move out. This means that the gift will be a potentially exempt transfer. The value of the property is its value at the date the reservation is lifted. If you live for seven years after making the gift, the £400,000 will drop out of your estate. If you die before then, it will be chargeable to IHT in the normal way, subject to tapering relief.

For capital gains tax purposes, however, your sons will be chargeable to tax on the disposal of the property. Their gains will be based on the growth in value of the property from the dates on which they acquired their respective interests. Therefore, one son will be taxed on the increase in the value of a half-interest since 1999, while your other son will be taxed on the growth in value of his share since 2002.

The values used are, however, likely to be lower than the open market values at those dates – shared ownership and the presence of a "sitting tenant" will bring the value down. Your sons should consult an experienced local valuer to make sure these factors are taken into account.

We purchased a new flat in October 2002 for £300,000 and, thanks to rising property prices, it is now worth about £350,000.

In fact, the flat has appreciated a lot faster than the value of our main residence and with capital gains tax (CGT) in mind, we have been led to understand that it may be possible to backdate a change in our main residence with the Inland Revenue for up to two years.

Can we apply this rule to our flat and then sell it, thereby avoiding CGT on the sale? Afterwards, we would revert to our house as our main residence.

However, presumably we would then be liable to pay CGT for this two-year period on our house, should we ever decide to sell it. How exactly would this be calculated, please?

Maggie Fleming writes:

It depends on how you have used the flat – you can only nominate it to be your residence if it has in fact been your residence, in the normal sense of that word.

Therefore, if, for example, you work in London and have lived in the flat during the week and returned to your house at weekends, you can make an election to nominate it as your main residence, backdated to the date of acquisition.

On the other hand, if you have let the flat out, you cannot make the election, as it stands to reason that it cannot have been your residence while being let.

The election must be made to the Inland Revenue, in writing, within two years of the date contracts were exchanged on the second property, so you need to take action immediately.

Once made, you can vary the election and, if you plan to sell the flat in the near future, this facility could be very useful to you. This is because, once a property is your main residence for CGT purposes, the last 36 months of ownership are automatically exempt. So, if you sell the flat by November 2005, the disposal would be CGT-free, even if it were only elected your main residence for a month.

Therefore, you could now elect for it to be your main residence from October 2002 but could vary the election in writing a few weeks later by re-nominating your house as your main residence from November 2002. This would have the effect of sheltering the entire gain you might make on the flat (assuming it is sold within 13 months) while exposing your main residence to a potential CGT charge for only one month.

My father, who is 88, has recently gone into a residential care home. Because he has a property, currently valued at £240,000, his residency is being totally self-funded.

He has some savings, which are being used to pay his present bills but the time is fast approaching when the property will need to be sold for him to remain in the home.

If this happens, and the money is sensibly invested, the interest earned will be almost sufficient, together with his pensions, to pay for his continuing stay in the home. Unfortunately, the interest will also be in excess of what he can earn without paying income tax. Is there any provision to offset the cost of his care against the income received before tax liability becomes due?

It seems anomalous that he is forced to sell his property to avoid the state paying for his upkeep, while expecting him to pay tax on any interest received. If only one could sell half the house to generate a smaller, tax-free, income...

Maggie Fleming writes:

Sadly, there is no provision to mitigate tax in this situation. However, it should be possible to generate some tax-free income for your father from the proceeds of sale.

You may wish to consider investing the money in an investment bond. These are offered by all the big insurance companies. If you require no more than 7.5 per cent per annum from the money, this would be ideal. The life company's funds are taxed before being paid to the investor and only higher rate taxpayers have to pay any additional tax. They offer a wide choice of funds. In times past, cautious investors used them to invest in a life company's with-profits fund but those funds have recently dropped out of favour. Now, an astute investor is likely to choose a combination of bond and property funds to achieve the income required.

If you need to generate more than 7.5 per cent, you may need to look at supplementing an investment bond with an immediate care annuity. If your father is ill, it might also be possible to secure higher than normal rates from an "impaired life annuity".

Of course, with an annuity, your father would be spending part of his capital. If the income is paid to your father, only part of it is taxed – most of it is treated as a return of capital. There may be tax advantages in having it paid direct to the care home, however. You should consult an independent financial adviser who specialises in long-term care. He can also advise on how the different investments would affect your father's entitlement to state benefits.