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Malcolm Finney considers an important aspect of the Capital Cains Tax relief for only or main residences.

Introduction

Inter-spouse transfers are generally not subject to Inheritance Tax (IHT) or Capital Gains Tax (CGT). However, inter-spouse transfers of interests in a sole or main residence are subject to special provisions (TCGA 1992 s 222).

Inter-Spouse Transfers

The basic rule for CGT purposes is that inter-spouse transfers (assuming spouses are living together) take place at "no gain/no loss" and at the date of the transfer (although the transfer takes place at no gain/no loss, a disposal for CGT purposes does still occur; it is not an exempt transfer; TCGA 1992 s 58). The transferee spouse thus acquires the interest in the property at the original cost to the transferor spouse.

However, with respect to inter-spouse transfers of an interest in a sole or main residence, whilst the transfer takes place at no gain/no loss (as normal) under certain conditions the recipient spouse’s period of ownership is deemed not only to commence (not at the date of the transfer but) at the date of the original acquisition by the transferor spouse; and any period during which the property was the sole or main residence of the transferor spouse shall also be deemed to be that of the transferee spouse (TCGA 1992 s 222).

In essence, the transferee spouse ‘stands in the shoes of the transferor spouse’ (i.e., there is a ‘back-dating’ effect to the transfer).

The ‘deeming’ referred to occurs irrespective of the real position; thus, a CGT fiction is in effect created for CGT purposes on inter-spouse transfers of an interest in a sole or main residence (subject to the transfer falling within specified conditions). The conditions referred to which, if satisfied, result in the back-dating effect are that at the date of the transfer of the interest in the property:

• the spouses are married and living together; and
• the property in which the interest is being transferred is their (i.e., both) sole or main residence.

Thus, even if at some time the property has been their sole or main residence, if at the date of the transfer the conditions are not satisfied no deemed ‘backdating’ arises. This may occur if, for example, the transfer takes place at a time when the property is let out or if another property is the couple’s main residence.

This backdating effect may, however, not always be desirable. Thus, for example, if the transferee spouse is to live in the property as his sole residence from the date of transfer of an interest in the property but there is a long period of time for the transferor when the property does not comprise her sole residence (e.g., when it was left empty) it may be preferable to effect any transfer of interest at a time when the property is not their sole or main residence.

Such a transfer then breaches the conditions which, if satisfied, result in backdating for the transferee spouse. The transferee spouse’s ownership period is then not diluted/tainted by the transferor spouse’s period during which the property was not the transferor spouse’s sole or main residence.

Example

Henry has been living overseas for many years but plans to return to the UK in the next ten years or so with his wife.

Whilst outside the UK Henry and his wife plan to purchase a house in the UK (50:50) which they intend to let out prior to their return to the UK.

After their return, any future sale of the UK property is likely to precipitate a CGT charge for each spouse because for ten years prior to their return to the UK, the property has not been either spouse’s sole or main residence.

One option might therefore be for the husband to purchase the property 100% and to let it out as planned. Just prior to returning to the UK the husband transfers 100% of the property to his wife.

The transfer takes place at the date of the transfer and is at no gain/no loss but involves no back-dating because at the time of the transfer the property is not their sole or main residence.

On any future sale by the wife 100% of the capital gain is exempt because throughout her period of ownership the house qualifies as her sole residence (the letting period of her husband is irrelevant).

If instead the UK property is purchased 50:50 by Henry and his wife prior to returning to the UK any future sale, after return to the UK, by either party will in part be subject to CGT because the first ten years do not qualify for the sole or main residence exemption.

The issue may also be in point where a sole or main residence is to be purchased but it is known that at some future time the property is to be let for some lengthy period. It may, in such circumstances, be better for one spouse initially to own the property with a view to a transfer to the other spouse, prior to returning to the property.

The important point to note is that inter-spouse transfers of interests in property, whilst often perceived as tax neutral may in fact precipitate - albeit unknowingly - a tax charge on a future sale; careful consideration is required prior to making any such transfers.

The above is adapted from Malcolm Finney’s latest book Personal Tax Planning: Principles and Practice published by Bloomsbury Professional.

A review of the book by Lee Young is featured elsewhere on the site.