Tax Doctor:
Mark McLaughlin
ATII ATT TEP

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October 2004

Q:

I own a house which I currently live in with my wife. I also bought a property a few years ago as an investment. I now want to sell both properties to invest in one single larger one. Do I run the risk of paying a large amount of tax on this?

A:

It all depends. Firstly, are the properties standing at a large gain? How much did you pay for them, and what is their current value? Secondly, have you lived in your current house ever since you originally acquired it? If so, any gain should be relieved from capital gains tax, on the basis that it has been your ‘principal private residence' throughout your period of ownership.

Capital or income?

This leaves the gain on your investment property to consider. By ‘investment' I assume you mean that the property was bought and subsequently let out, as opposed to (for example) bought and renovated with the intention of selling it for a profit. This distinction is important. The disposal of an income generating investment such as a buy-to-let property will normally be subject to capital gains tax, whereas property development is generally liable to income tax, either as a trade or under anti-tax avoidance rules concerning transactions in land and buildings. Capital gains tax treatment is generally considered better than income tax treatment, due to the potential availability of various reliefs (e.g. taper relief – see below) and the annual exemption (£8,200 for 2004/05).

Taper relief

You bought the property ‘a few years ago'. A measure of capital gains tax taper relief may be available. Taper relief reduces gains by a fixed percentage according to the length of ownership and whether the asset is a ‘business' or ‘non-business' asset. The rates of taper relief are more generous for business assets than for non-business assets. Business assets attract maximum taper relief of 75% after 2 years. Non-business assets receive no taper relief until year 3 of a 10 year maximum holding period. The rate of relief thereafter is 5% per annum, up to a maximum of 40% after ten years. For an investment property, the non-business asset rate of taper relief normally applies (unless the property is a furnished holiday letting), but only if the property has been owned for at least three complete years. If ‘a few years' means three years, the gain is likely to be reduced by 5% taper relief. The remaining gain can be further reduced by your annual exemption, provided that it is not used against other capital gains of the same tax year. I have not mentioned offsetting capital losses so far, as I have assumed that none are available. However, if you do have any capital losses from the disposal of other assets (either in the current year or brought forward from earlier years), these are set against gains before deducting taper relief and the annual exemption.

Joint ownership

our query suggests that both properties are owned in your sole name, as opposed to jointly with your wife. It might be worth considering transferring an interest in the investment property to your spouse, to make use of her annual capital gains tax exemption assuming that it is not used elsewhere. Joint ownership of property can also be tax-efficient if you are a higher rate taxpayer and your wife pays tax at a lower rate, or not at all. However, this option requires careful consideration. For example, if you transfer a share of the property to your wife while it is already on the market and a potential sale is imminent, this could upset the taxman! On the other hand, if you transfer an interest to your wife and she receives a share of rental profits for a reasonable period of time (e.g. a few months, but the longer the better) before the property is marketed and sold, the Inland Revenue is unlikely to object. In addition, if the property is mortgaged and the loan is transferred into joint names with your wife when a share of the property is transferred, there could be stamp duty land tax implications if the loan transferred to your wife is substantial. Professional advice should always be sought, based on the specific circumstances.

Mark McLaughlin

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