CGT on rental property

[kbbc]

The parents of my girlfriend bought a property in her name back in 1986. The property has been let ever since (with the exception of a few short periods of renovation). She has never lived in the property. She has been reporting the rental income on her tax returns. Her parents now want to sell the property.

- I assume that she will be assessed CGT on the gain that arises - what reliefs are open to her to minimise the CGT liability?
- If it would be necessary for her to move into the property for a short while to establish it as her main residence how long would this have to be for?


The situation is slightly complicated by the following:

She bought a rental property in her own name in August 2002 which she in effect lived in until January 2003 - it has been let out ever since. This is the only property that she has owned that she has lived in - for the remaining time she has either lived with her parents (property owned by parents) or myself (property owned by myself).

Any guidance on the CGT position gratefully received.

[Instinctive]

REPLY

Reply to your last paragraph first.
The property bought in August 2002 is her 'only or main residence' for Capital Gains Tax purposes as she has occupied this until January 2003 as such.This ensures that all her gains on this property (if and when this is sold in the future) will be exempt for a further 3 years from January 2003, ie upto January 2006. Additionally, assuming that the property is let as a residential accommodation, she could be entitled to a reduction in her gains thereafter by upto a further £40,000. The exact figure would need to be worked out. She is also entitled to her Annual Exemption of gains (Currently £8200) in the year of disposal. Therefore, she will have practically very little or no gains on which to pay tax for some time yet. Carefully review tax planning for this some time before selling.

Now to the main point of your query.
The property is said to be bought by the parents in the daughters name only and she has been declaring all the rental profits to the Tax office. But the parents are deciding the sale of the property. In view of this, I ask you to consider carefully whether the property has been meant to belong to the daughter at all times. Is it possible that the parents have retained a 'beneficial interest' in the property ? Will she get to keep all the monies from the sale of the property ?

Assuming the property is owned, not only legally, but also beneficially, by the daughter at all times since its purchase in 1986, it is unfortunate that it has never been occupied by her as her only or main residence until she bought the other property in 2002. This means that she cannot get the very generous tax breaks afforded to a property which has been her main residence at any time in her ownership.

She will be allowed to deduct the original purchase price of the property, all the acquition costs (eg legal,valuation ), subsequent improvement expenditure which she has not already claimed as a deduction from her rental income, and all selling expenses. She will also be able to deduct an inflationary allowance, known as 'Indexation Allowance' from the date of purchase upto 5 April 1998. This will amount to approximately 65% of the original purchase price. For the periods after this date, this allowance has been replaced by what is known as 'Taper Relief'. This relief is applied as a percentage reduction of the remaining gain after all above mentioned costs and allowances have been deducted.The Taper Relief reduction will be 25% if sold on or before 5 April 2005 and 30% if sold on or after 6 April 2005. Finally, she will have her Annual Allowance to claim which is £8,200 for the current tax year ending 5 April 2005. It will be approximately £8,600 if the sale is after 5 April 2005.

As for tax planning, she can decide not to sell and instead raise any required funds by remortgaging the property. She could decide to sell partly in this tax year and partly in the next tax year to avail herself to two lots of Annual Allowance. This is only practical if selling to a relative. She could occupy it as a main residence but it is the quality of occupation which is more important than the length of occupation. As a rule of thumb, at least six months is the minimum term of occupation. This would enable her to have the final three years gain tax free. Additionally, she could also possibly qualify for a further tax free gain of upto £40,000 if the property has been let as a residential accommodation at any time in her ownership.

RP

[kbbc]

Ramnik - many thanks for the comprehensive reply. The summary of the how the Indexation Allowance, Taper Relief, and Annual Allowance all link in with eachother was just what I was looking for.

After further discussions though, I understand that it is likely that her parents will keep the proceeds from the sale of the property. (I am trying to keep out of the family politics and trying just to look at the facts!) As such I need to find out about the 'beneficial interest' aspect. How would this affect the tax treatment of the sale of the property?

[Instinctive]

Technically, the property belongs to the beneficial owners who may not necessarily be the legal owners. The property could possibly be deemed to be owned beneficially by the daughter alone, or by either parent alone, or by her and the two parents jointly or by the two parents jointly. Just because the parents may keep all the sale proceeds may not necessarily imply that the property has belonged to them. The fact that the property is in the daughter's name and further that she has always declared the rental profits, will count heavily against her.

By trying to declare that the property is owned beneficially by any combination other than the daughter alone, you could be opening up a can of warms.

But if you must, I suggest a visit to your solicitors to draw up a Trust Deed to reflect the actual beneficial ownership of the property and the reasons why only daughter's name was put on the title deeds. The sale of the property could then be declared by the beneficial owners in their individual Self-Assessment tax returns. Each person will be assessed on their respective shares and also be entitled to their individual Annual Exemptions to the extent that these are not used against other gains in the same tax year. Also by spreading the gain over more than one person, the gain could become taxable at lower rate of CGT at 20% rather than the higher rate of 40%.

I feel that you should consult a professional tax advisor for assistance and guidance because there are also implications other than the ones mentioned above, eg, what date is the change to be effective from, possible implications of deemed transfer to the parents, possible hold-over elections etc.

Finally, and most importantly, I advocate being totally honest and open with the Inland Revenue.

[kbbc]

Thanks for the info. I agree that the honest & open approach is the best way forward!