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In the second of a series of articles, Malcolm Finney, author of 'Personal Tax Planning: Principles and Practice', looks at inter-spouse transfers of a married couple's only or main residence.

Transfers between Spouses

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

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 still occurs; 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) at the date of the original acquisition by the transferor spouse but 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 ‘backdating’ effect to the transfer).

The ‘deeming’ occurs irrespective of the real position and even applies where, at the date the transferor spouse initially acquires the property, the transferee spouse and transferor spouse are not in fact married (perhaps did not even know each other at that time). In effect, a CGT fiction is 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 which, if satisfied, result in the backdating 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 above are not satisfied then 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 their main residence (possibly by election).

Example 1

Alice Spring acquires her house on 1 July 1999 for £200,000 and marries Jim Horse on 1 July 2002 when the house is worth £250,000.

As a wedding present Alice transfers (after they are married) a 50% interest in the house to Jim (prior to marriage Jim had lived with his brother in the latter’s house) on 1 July 2002.

On 31 May 2010 they sell the house for £650,000.

On 1 July 2002 when Alice transfers 50% of her interest to Jim the house is their sole residence. He is thus deemed to have acquired that interest for £100,000 (i.e., 50% of the original cost to Alice) and at the date Alice bought the house (1 July 1999). As between July 1999 and the date of marriage the house has been Alice’s sole residence and it is thus similarly treated as such for Jim.

On the sale on 31 May 2010 the capital gain each spouse makes is £225,000 (i.e., £325,000 less £100,000).

Throughout the period of ownership for each spouse the house is (or in Jim’s case is deemed to be) their sole residence and thus no CGT arises for either spouse.

Example 2

Assuming the same circumstances as Example 1 except Alice transfers the 50% interest in the house to Jim on 1 July 2001 (i.e., prior to their marriage (value £220,000)).

At the date of the transfer Alice and Jim are not married and, in addition, Alice’s house is not the sole or main residence of Jim as he does not reside there.

The relevant conditions are not satisfied and thus no ‘backdating’ or ‘standing in the shoes’ occurs.

The 50% takes place at the date of transfer but at market value (TCGA 1992 s 58 inapplicable; TCGA 1992 s 17 applies). However, as the house has been Alice’s sole residence throughout her ownership no CGT is precipitated at that time on the disposal by her of the 50% interest to Jim.

Jim is thus assumed to have acquired the 50% interest at the date of transfer for its then market value of £110,000.

On sale on 31 May 2010 no CGT arises on the part of Alice’s 50% retained interest for the reasons in Example 1 (i.e., it is her sole residence).

However, between 1 July 2001 and 31 May 2010 (107 months) the property is Jim’s sole residence only from 1 July 2002 (when he moves into the house). Jim’s capital gain chargeable to CGT is thus:

12/107 x [£325,000 - £110,000] = £24,112

CGT = 18% x [£24,112 - £10,100] = £2,522 (Annual Exempt Amount for tax year 2010–2011 £10,100).

A comparison of Examples 1 and 2 reveals that Jim’s CGT liability (ignoring the Annual Exempt Amount) is avoidable by effecting the transfer of the interest in Alice’s house after they are married (i.e., when the house qualifies as their sole residence).
 
There are, however, circumstances in which the ‘backdating’ can be counter-productive.

Example 3

Alice Spring acquires her house on 1 July 1990 for £200,000 and married Jim Horse on 1 July 2006 when the house is worth £600,000.

Between 1 July 1991 and 30 June 2001 Alice leaves the house empty (i.e., it is not used by her as a residence) whilst she lives with her mother.

As a wedding present Alice transfers (after they are married in July 2006) a 50% interest in the house to Jim (prior to marriage Jim had lived with his brother in the latter’s house) on 1 July 2006.

On 30 June 2010 they sell the house for £650,000.

On 1 July 2006 (market value £500,000) when Alice transferred 50% of her interest to Jim the house is their sole residence. He is thus deemed to have acquired that interest for £100,000 (i.e., 50% of the original cost to Alice) and at the date Alice bought the house (i.e., 1 July 1990). Between 1 July 1991 and 30 June 2001 the house is not Alice’s sole or main residence and is thus similarly treated as such for Jim.

On the sale on 30 June 2010 the capital gain each spouse makes is £225,000 (i.e., £325,000 less £100,000).

The capital gain chargeable to CGT for each spouse is:

120/240 x [£325,000 - £100,000] = £112,500.

Now assume Alice transfers the 50% to Jim on 1 June 2006 (i.e., one day prior to marriage).

Jim is deemed to have acquired his interest on 1 June 2006 at the then market value (i.e., £250,000).

Jim’s capital gain chargeable to CGT is in fact nil as he has lived in the property from the date of transfer to the date of sale (i.e., the whole of his period of ownership).

Example 3 illustrates that if the transferee (i.e., Jim in Example 3) is to live in the property as his sole residence from the date of transfer of an interest in the property (i.e., 50% in Example 3) and there is a long period of time for the transferor (i.e., Alice in Example 3) when the property does not comprise her sole residence (e.g., when it was left empty) it is preferable to effect the 50% transfer at a time when the property is not their sole or main residence.
 
This 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 is not the transferor spouse’s sole or main residence.

The following example also illustrates this important point.

Example 4

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 backdating 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).
 
The conditions and the backdating are also applicable to transfers on death. Where a transfer of an interest in a sole or main residence occurs on death, between a husband and wife who are living together, the surviving spouse is deemed to have acquired the interest at the date the deceased acquired the interest and any period during which the deceased’s interest qualified as his sole or main residence is also attributed to the surviving spouse with respect to that interest (TCGA 1992 s 222).
 
However, the surviving spouse acquires the interest from the deceased spouse at probate value (i.e., market value) and not at the value at the date of the original acquisition by the deceased (TCGA 1992 s 62).

The above article is based on an extract from 'Personal Tax Planning: Principles and Practice', by Malcolm Finney, published by Bloomsbury Professional. For further information and to order the book, please visit Tax Boookshop (Personal Tax Planning: Principles and Practice, 2nd Edition).