CGT on house conversion

[Tamarix]

I have lived in my house for eight years and decided to turn it into two flats and sell one to reduce the mortgage. Until the conversion was complete I lived in the whole house and then sold the lower flat and moved upstairs to the top flat. As it is my PPR am I liable to CGT on the sale of this one flat. Then, if at a later date, say a year or twos time I decide to sell the one I am living in would this be liable to CGT. I have searched the site for a similar situation, but cannot find an answer. I am a self employed plumber and did the conversion myself, but am not sure where I stand regarding my house. I would really appreciate any help or pointers as to where to look. Many thanks in anticipation of a reply.

[oxfordtaxman]

PPR available on time basis to cover 8 years of actual residence (prior to conversion).

Last 36 months of ownership exemption is NOT available on the lower flat.

Therefore CGT due on period from conversion up to date of disposal.

[jbaileycta@btopenwor]

Dear Puffinette

I am afraid the situation is a little more complicated than the other reply suggests.

The exemption for your main residence is restricted when you spend money "wholly or partly for the purpose of realising a gain from the disposal" (section 224 (3) Taxation of Chargeable Gains Act 1992).

Splitting your house into two flats and selling one of them is the textbook example of this situation, so there will be a capital gain on the sale of the first flat. The calculation is a little tricky, because it involves identifying how much of the gain is attributable to the cost of conversion.

Have a look at the Inland Revenue's website, and go to the "practitioner zone", then to "manuals", then to "Capital Gains Manual", then to paragraph CG65241, and read on.

If you find the contents as confusing as I found my last attempt to repair our plumbing, please feel free to contact me - I can do the calculation for you for a reasonable fee. It can pay to use a professional - my plumbing efforts caused about £100 worth of damage to my kitchen!

James Bailey
Chartered Tax Adviser
01822 810169

[Instinctive]

So you are a plumber. Some could argue that you are not in the building trade. If so, you could escape being taxed on the developement profits as a business rather than CGT.

Have you undertaken anything like this in the past? If not, this helps.

I am of the opinion that you will get PPR relief upto the point of commencement of conversion. The conversion profits will then be charged to income tax / NIC4 or CGT depending on actual facts in your case.

I would seriously consider letting the lower flat for a while. This may help in not being classed as a developer. You could also switch your residence to the lower flat at a later date and sell the upper flat which would be CGT free due to PPR relief, including last 36 months.

Ramnik

Ramnik

[jbaileycta@btopenwor]

Don't worry about the gain on the flat being treated as trading profit instead of CGT as Ramnik suggests - because you originally lived in the whole house as your main residence, it would be very difficult if not impossible for the Revenue to argue that any of it was part of your stock in trade.

Since you have already sold the lower flat, it is a bit late to let it as Ramnik suggests.

I am afraid that it is also not the case that any future gain on the sale of the upper flat will be automatically covered by PPR relief. The correct way to compute the gain on the lower flat is as stated in my previous contribution. As far as the upstairs is concerned, when you come to sell that, it will be necessary to do a similar computation to arrive at the part of the gain on that which is attributable to the expenditure on the conversion - see the example at CG65271 in the Inland Revenue's Capital Gains Manual.

Sorry contradict the other two contributors, but it is important that you follow the correct method to compute the gains - to do otherwise would mean that you would risk penalties for an incorrect tax return.

James Bailey
Chartered Tax Adviser
01822 810169

[Tamarix]

Thank you all for your contributions. I have been away and just returned from holidays! Yes, this plumber does have holidays!! I am now confused as to the reference to the top floor flat being eligible for CGT if I sell it in the future, as it is now and will be my PPR until I do sell it. Would that not then be CGT FREE ? I am not a property developer, just wanted to downsize my home and have a cheaper mortgage. Also if I did the conversion in tax year 2004/5 but it was not sold until July 2005 what do I do about the comnversion costs, etc, do they go on my SA Tax Return for 2004/5, which would make my business into a LOSS for that year ! Or do I have to make an election or something as the CGT (if due) would be this current year 2005/2006.

Love this site, can't believe we all have so many headaches, makes you feel like one big family.

Well done, originator, fantastic.

[jbaileycta@btopenwor]

Dear Puffinette

Whatever you do, don't put the costs of conversion through your business books - this will make the conversion and sale into a trading venture, liable to income tax not CGT, and will prejudice your relief for main residence.

I have explained in my previous two answers how the calculation works. The point is, the conversion was done to realise a profit by selling the downstairs flat, so relief for main residence is restricted. Note it is only restricted, not taken away altogether - in fact you may well find that the gain not covered by the exemption is quite small.

The same sort of restriction will apply when you eventually sell the upstairs flat, because a house divided into two flats will fetch more than the same house not divided, and the "extra" part of the gain that is a result of the division of the house is not exempt from CGT.

Have you looked at CG65271 yet (see my reply of 10 August)? Go to the Inland Revenue's website, click on "practitioner zone" in the top RH corner of the home page, then click on "manuals" in the "library" section, then on "Capital Gains Manual", and find paragraph 65271. This gives a detailed explanation of how to do the calculation, both for the sale of the first flat and for the second.

The gain on the sale of the flat sold in July 2005 (calculated according to CG65271)should be reported in the Capital Gains section of your return for 2005/2006. The conversion costs are treated as shown in CG65271, and form part of the calculation in the 2005/06 return.

I hope that covers all your questions.

Regards

James Bailey
Chartered Tax Adviser

[Tamarix]

Dear James

Yes, thankyou for your explanation I now feel I understand more about the way it works! Bearing in mind that I still have the rest of this tax year to computate it, I will gather and prepare the appropriate paperwork, etc., for the computation. When the time comes, should I need help I will contact you, as above.

Thankyou James and all who listened to me.
Regards,
Puffinette.

[jhutc16]

Dear anyone,

What if you are converting your (co-owned) house into two flats because you want to stay in the house -- and will initially live in the upstairs flat (which will be converted first) while the ground floor flat is being converted, then sell the upstairs flat and move back downstairs -- as a way of dividing up the joint assets in a divorce?

jhutc16

[lindaalex]

To jhutc16
I came onto the site to check on exactly that point.
My husband and I have decided to split and I do not particularly want to move. He is of course entitled to half of the value of the house. I have considered re-mortgaging to pay him off and it is possible, but would leave me extremely skint, so it might make sense to actually split the house into an upstairs/downstairs situation. I assume then that both properties would become main residences in our individual names and if he or I decided to sell at a later date that should not incur CGT? Does anyone have any expertise in this area?
l.a.