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

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We are selling our rental flat after 12 years and are frightened of being clobbered by CGT. Are there are any loopholes?

There are a number of useful reliefs and exemptions you can claim. For anyone selling a property, much will depend on whether or not it has ever been their home. If it has, you can claim Principal Private Residence (PPR) relief for any period when it was your only or main residence, plus the final three years of ownership in all cases.

This means that, if you have always lived there - or moved out less than three years before selling up - you will not have to pay any tax at all.

If you moved house and then rented out your old home, you could have additional relief on top of PPR.

This extended relief can exempt up to a further £40,000 of any gain not already covered by PPR. The relief is allocated to a person, rather than a property, so if a husband and wife own a property jointly, they could have up to £80,000 knocked off the gain in this way.

That's an option for us. Is there anything else?

There are other reliefs that apply to all properties and not just to those residences qualifying for PPR. If you owned the property before 1998, you will qualify for indexation allowance, which was based on the Retail Price Index and was intended to strip out the inflationary element of the gain. This was abolished in 1998 (when inflation looked dead as a dodo) and replaced by taper relief, which, after you have owned the property for three years, knocks 5 per cent per annum off the gain each year until year 10 - so the gain will be reduced by 40 per cent after 10 years. This is intended to encourage and reward long-term ownership rather than short-term speculation.

Can we drag anything else back?

You should never overlook the annual CGT exemption - currently £8,500.

As spouses (and, from this December, civil partners) can transfer assets between themselves without tax consequences, it makes sense to gift a half share to your spouse or civil partner before a sale so they can make use of their annual exemption as well as your own. You need to do the calculations first, but this could result in a lower overall tax rate. However, the gift must be made with no strings attached.

Although retaining the family home, we are considering buying a London flat. The plan is to let the flat in the early years and use it ourselves on our retirement.

However, there is a tax issue. We aim to acquire the flat in my wife's name with a view to her receiving the rental income since she has a relatively low income. Part of the purchase price must be funded via mortgage, and our existing mortgage lenders have suggested the simplest route is by increasing the (small) mortgage on the family home, which is in our joint names.

The concern, therefore, is that if we increase our existing mortgage to part finance the purchase of the flat, will my wife be able to offset the interest expense against rental income from the flat?

Maggie Fleming writes:

It would, of course, be easier from a tax point of view (but presumably more expensive) if there were a separate loan for the rental property. Nonetheless, the route suggested by your lender should not cause any problems for your wife, provided that it is clearly documented that the increased loan is to fund the purchase of the flat.

The Inland Revenue's internal manuals state that, provided your wife pays the interest that relates to the rental property, she will be entitled to relief in full. This will apply even if the payments are made out of a joint account. However, to ensure that there is no question about this, your wife would be well advised to make the interest payments relating to the flat from a separate account - it would be sensible to have a separate account for the rental business in any case. Your lender will also be able to provide a certificate of interest at the end of each tax year showing the amount of interest paid on the interest-only part of the loan if the Inspector of Taxes asks for proof.

Besides the house that I live in, I own a flat and a small comercial property, both of which are let. The gross income from these two properties is £16,500 per annum which supplements my small pension.

I no longer have a loan on the properties and the annual service charges and repairs are £1500. As an alternative to claiming the 10 per cent "wear and tear" on the rent income, would I be better off to claim relief under "the room to let" scheme or establishing a limited company? Or do you have any other suggestions to reduce income tax?

Maggie Fleming writes:

The "rent a room" scheme applies only where you are letting out part of your only or main residence. As you are not living in the flat, the income will not qualify for "rent a room", so that idea is a non-starter.

Provided that the flat is let furnished, the 10 per cent "wear and tear" allowance applies, as an alternative to claiming the actual cost of replacing movable items such as beds, sofas, crockery, cutlery, TV, fridge, cooker etc. But, in addition, you can claim the cost of repairing such items.

Furthermore, in addition to the 10 per cent allowance, you can claim the cost of renewing fixtures which are integral to the property, such as baths, washbasins and toilets. And you can, of course, also claim the repairs and service charges you mention.

The "wear and tear" allowance is not available on the commercial property you let but you can claim capital allowances on plant and machinery instead. I doubt that forming a limited company would help.

Until a few years ago, people with modest profits were incorporating their businesses and paying themselves dividends in order to pay little or no tax but the Chancellor of the Exchequer closed this loophole last year.

Don't forget that incorporation means lots of administrative hassle. My view is that it is probably better to leave things as they are (assuming that you claim everything you are entitled to in the way of expenses) but you should check the matter in detail with a qualified tax practitioner.

Following a relationship of almost 20 years where we both lived in our own houses, my partner and I got married in February. However, we continue to live in our own properties and do not see this changing in the foreseeable future.

With regards to Capital Gains Tax (CGT), one expert has said that within three years we will have to nominate one of our properties for CGT. Expert No 2 says that as long as we are not living in the same house, neither of us is subject to CGT. We both own our own houses and have only our names on the deeds. Could you help clarify this?

Maggie Fleming writes:

I'm sorry to say that both your experts are wrong, although expert No 1 is almost right! A married couple can have only one principal private residence between them. But you have only two years, not three, from the date of marriage in which to make a joint election for the one qualifying for the relief.

The main consideration in choosing which property is the one likely to produce the greater gain on sale. Remember that the final three years of ownership of a house which has at any time been your only or main residence is always tax-free, so, if it were likely that one would be sold within three years of marriage, you should nominate the other.