How Much Is A Bedroom Worth?

[james87]

I have a slightly unusual situation that I am struggling to find a clear answer to. Circumstances as follows:

My wife and I purchased Property A as our main (and only) residence in 2016. Property A has a flying freehold, whereby one of the upstairs bedrooms is in fact part of neighbouring Property B (i.e. Property A has one fewer bedroom than it should have). As I understand it, at some point in the distant past Properties A & B were one larger property, which was subsequently split up in this unusual way.

In 2019, we purchased Property B and moved into it while retaining Property A and letting it out. We now live in Property B as our main residence and we paid the full additional 3% stamp duty on the purchase. Property A is unencumbered, Property B is mortgaged, both are owned in our joint names.

My ultimate goal is to remove the flying freehold, by "returning" the bedroom to Property A and effectively creating two normal houses. This will significantly increase the value of Property A (for obvious reasons), which will then be sold. It will have a much less significant impact on Property B.

I want to do this in the most tax efficient way possible, so I have two questions:

1) How will the bedroom being transferred from one property to the other be valued? I can't sell it to myself, so I don't see how this would be calculated. We are outside of the window for full PRR on Property A so any gain will be taxed and could be quite significant.
2) An alternative I have considered is if Property A were initially sold to a Ltd Company to operate the rental business, would it then be possible for the company to buy the bedroom for effectively the amount by which it increases the value of Property A (which seems to me to define the "market value" of that bedroom). This would limit the size of the capital gain in the company, and lead to a larger value disposal of part of Property B, where I think we would benefit from PRR. I will also be able to recoup the additional stamp duty initially paid on the purchase of Property B in 2019, which will be greater than the amount owed by the company on the transaction (by approx £10k) and therefore negate any SDLT implications.

Any help gratefully received!

[bd6759]

Redrawing the boundaries between 2 properties that you own is not a disposal, and has no CGT consequences.

The only area of interest is when you come to sell the property. What was the cost of A now that it includes Part of B.

It might be that the bedroom could be valued in the same way as a ransom strip. I think that is half the difference of the increase in value, but that is really for an experienced valuer to determine.

[james87]

Thank you, that's useful. I see what you mean that the redrawing of the boundaries would (obviously, thinking about it!) not create a disposal in and of itself.

I think I might have thought of a different, more straightforward solution, which is to do the works required to redraw the boundary but not amend the title. Then, market Property A with the bedroom included, but the transaction be for two separate parcels, with the bedroom part priced accordingly. Does that work?

[bd6759]

Hang on. Do you mean the bedroom physically belongs to B. It is accessed from B and used by B. A has no access at all, it’s just within its footprint?

[james87]

The best way to explain the current layout is to imagine two terraced houses. At some point in the past, an owner of both houses has banged a big 'ol hole through the dividing wall, into Property A's bedroom. The door that lead into this bedroom from inside Property A has then been blocked up. Property A owns the room underneath, and the roof over the top, there's just a chunk missing from the footprint on the first floor, that currently belongs to Property B. Hope that makes sense!

[bd6759]

That’s easy then. The allowable cost of A is increased by the decrease in value to B, and the cost of B is decreased by that same amount.
The costs of conversion are also added to A.

A valuer should do that for you. You want the difference to be as much as possible if B will always be your PPR until sold ( and thus exempt from CGT so the cost reduction doesn’t have any effect).

[james87]

Thanks for that. Sorry if I've misunderstood, but unfortunately I think that's effectively the outcome I'm trying to avoid, as the diminution in value to B is going to be smaller (significantly) than the increase in value to A, therefore leading to a larger capital gain on the sale of A.

I totally accept that if there is a gain, it should be taxed accordingly, however I think the calculation method you have outlined leads to a disproportionately high taxable gain. In a scenario where A was owned by a third party, that third party would be willing to pay a lot more than the figure that would be calculated above for the bedroom. (A is a smaller house with fewer bedrooms, plus has a totally compromised layout due to the flying freehold, so the restoration of this bedroom resolves what has historically been quite a large barrier to sale. The price that this hypothetical buyer would pay is independent of the amount that the value of B is reduced).

In the scenario with two independent parties, much more of the value created by selling the bedroom accrues to B (and is therefore exempt from CGT as it is our PPR).

What I'm trying to do is structure the transaction in such a way that it reflects, in my opinion, the commercial reality of the situation and doesn't distribute the gain "unfairly". This is why I suggested the company in the original post, as this would introduce a (connected) third party that could pay this market rate for the bedroom. The market rate could be determined as you have outlined, by a valuer simply calculating the value of property A with and without the bedroom, the difference being the value minus the costs of conversion...

[bd6759]

The gain is not disproportionate. It reflects precisely the cost of your assets.

[james87]

Thanks for bearing with me! I definitely understand a lot more now, but I'm still not convinced the outcome is correct. What I'm trying to do is to structure things in a way that would reflect the situation if the properties were owned by two independent parties. The gain in your post does not reflect this - the price that an owner of A is willing to pay for the bedroom is totally independent of the reduction in value to B, this amount simply represents the minimum that an owner of B would likely accept.

Put simply, the transfer of the bedroom from B to A creates value in Property A over and above just the addition of the bedroom. This is the value of owning a house that doesn't have 33% of its upstairs footprint missing, and where all of the windows that look out onto your garden belong to your own house.

In an arm's length transaction, two parties would agree a price that shared this created value amongst them. In your example, all of the value is created in Property A, and is taxable. I am trying to see if it is possible for some (if not all) of this value to be attributable to Property B, as would be the case in a market transaction.

Are you able to advise whether introducing a company, as mentioned in the original post, would allow this to happen? Or if there's another method, such as selling the two elements separately (but in one linked transaction) that could achieve it?