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29 November 2000
Retirement strategy
Husband and wife clients occupy a sizeable property with several acres of land with a total value in the region of £600,000. The purchase price ten years ago was £400,000. They are thinking of retiring to a smaller property and are considering a number of options in addition to the traditional sale.
It is likely that planning permission could be obtained to demolish the existing property and build three new houses which would realise significantly more than a straight sale after building costs. The alternatives being considered are as follows:
Husband and wife clients occupy a sizeable property with several acres of land with a total value in the region of £600,000. The purchase price ten years ago was £400,000. They are thinking of retiring to a smaller property and are considering a number of options in addition to the traditional sale.
It is likely that planning permission could be obtained to demolish the existing property and build three new houses which would realise significantly more than a straight sale after building costs. The alternatives being considered are as follows:
Retirement strategy
Husband and wife clients occupy a sizeable property with several acres of land with a total value in the region of £600,000. The purchase price ten years ago was £400,000. They are thinking of retiring to a smaller property and are considering a number of options in addition to the traditional sale.
It is likely that planning permission could be obtained to demolish the existing property and build three new houses which would realise significantly more than a straight sale after building costs. The alternatives being considered are as follows:
* Obtain planning permission and then sell to a developer.
* Demolish the existing property, arrange for the construction of three houses and sell them individually.
* Demolish the existing property, arrange for the construction of three houses, and give one to each of their three children.
Views are sought on the application of principal private residence relief for each case and whether there are any ways of avoiding any potential pitfalls.
(Query T15,718) — Late Developer.
Answers:
There are three main areas to consider:
Firstly, whether the private residence exemption in section 222, Taxation of Chargeable Gains Act 1992 would apply to the extent that the area of the property exceeds the permitted area of 0.5 of a hectare. Section 222(3) says the permitted area can be larger where the area is required 'for the reasonable enjoyment of the dwelling house as a residence, having regard to the size and character of the dwelling house'. The property in question is sizeable with several acres, so further consideration should be given to ensure the exemption will apply to the whole property.
Secondly, whether an application for planning permission will create a restriction in the amount of the exemption available. Section 224(3), Taxation of Chargeable Gains Act 1992 states that relief shall not apply 'in relation to a gain so far as attributable to any expenditure …. incurred wholly or partly for the purpose of realising a gain from the disposal'. Fortunately the Revenue has said that obtaining planning permission will not trigger a restriction in private residence relief (see paragraph CG 65243 of the Capital Gains Tax Manual).
Thirdly, whether principal private residence relief will be lost if the clients develop the site themselves. Section 161(1), Taxation of Chargeable Gains Act 1992 states that where an asset is appropriated to trading stock, the taxpayer will be treated as having 'disposed of the asset by selling it for its then market value'. A transfer to trading stock will therefore trigger a capital gain and also private residence relief.
Applying the above to the alternatives put forward:
* If the clients obtain planning permission and then sell to a developer, they will be able to claim private residence relief subject to a restriction depending on the size and character of the house.
* If they demolish the property and develop it themselves, they will be treated as commencing a trade of property development. The gain on the appropriation to trading stock will qualify for private residence relief depending on the size and character of the house. The profit on the property development will be taxable under Schedule D, Case I.
* If they carry out the development themselves and then gift the new houses to their children, the gift to the children will create a profit taxable under Schedule D, Case I but without the sale proceeds. Furthermore it will be a potentially exempt transfer for inheritance tax.
There are other alternatives:
* The parents could give the undeveloped plots to their children. This would reduce the value of the potentially exempt transfer and also allow the profit to be taxable on the children. If the children develop and occupy the properties, they will be able to claim private residence relief on the gain when they sell.
* The parents could set up their own property development company and sell the property to the company, leaving the proceeds outstanding on loan account. This would trigger a capital gain and the private residence exemption. The profit in the company could be extracted in a tax-efficient way by gifting shares to the children and paying dividends. (However, stamp duty would be payable on the sale to the company.) — G.S.
This is like a chess problem where two of the alternatives lead to immediate defeat by checkmate, while the other leads to victory (or at least a draw).
The exemption in section 222, Taxation of Chargeable Gains Act 1992 is for 'a dwelling-house or part of a dwelling-house which is, or has at any time in his period of ownership been, his only or main residence …'. If the main residence is demolished and replacement houses are built, it is likely that no main residence relief will be available at all. The exemption does not apply to the land on which the main residence once stood. There is no possibility of time apportionment between the period during which it did qualify (many years) and the recent non-qualifying period, as there is when the house itself is sold but has not been occupied throughout the period. The exemption is altogether lost.
The land around the house will also not qualify, unless it is the 'garden or grounds' of the main residence at the time of the disposal (Varty v Lynes [1976] STC 508).
If a single house was built to replace the original house, and the owner resumed occupation as main residence, the Revenue might accept that the main residence exemption applied to the disposal. However, if the disposal was very shortly after resuming residence, and was clearly envisaged at the time residence was resumed, then the occupation might not have the necessary degree of 'permanence' as discussed in Goodwin v Curtis, CA 1998. If three houses are built, it would clearly not be possible to occupy all three of them.
The Revenue applies the rule in section 224(3) to expenditure on actual development, for example convertinga barn into a house. So there would be a chargeable gain in relation to the expenditure in the second option, even if the Revenue accepted that some main residence relief was due. It might be possible to persuade the Revenue not to apply section 224(3) where the three houses are given away to children, because it would appear that the expenditure was incurred out of generosity rather than to realise a gain. But it is still likely that the Revenue will not accept that the relief is available at all.
Lastly, there is the question of the 'permitted area'. The legislation allows half a hectare of garden or grounds, or a larger area if it is 'required for the reasonable enjoyment of the dwelling-house … having regard to [its] size and character'. Half a hectare is about an acre; it is likely that the Revenue will want an apportionment of the gain to some of the 'several acres'. The procedure is discussed in Tax Bulletin 2.
Although it is normal for most of the value on a sale to attach to the house rather than to the grounds, in this case the house is to be demolished. If the planning permission puts the new houses in the 'non-permitted areas' (i.e. at some distance from the existing exempt main residence), the Revenue may argue that the value on sale should be apportioned simply by area. It might also argue that the cost should be apportioned on the basis of the value of land and buildings at the time of purchase, so the cost of the grounds would be a much smaller fraction of the total cost. This would again lead to a substantial chargeable gain.
In conclusion then, the demolition of the property before sale appears to lose the exemption completely. Obtaining planning permission which envisages demolition may also lead to a significant chargeable gain, unless all the new houses will be built within the area of half a hectare around the existing house. — Gardener.
Extracts from further replies received:
The first alternative, obtaining planning permission and selling to a developer while the house is still standing would still qualify for relief, subject, in the case of the surrounding land, to the limitations dictated by section 222(3). It was said in Tax Bulletin No 12 (August 1994) that it is not the Inland Revenue's practice to invoke section 224(3) where the only expenditure was on the obtaining of planning permission.
This proposal may not, however, be a viable proposition in the light of recent changes to planning law and practice. Before granting an outline consent, the local authority would need to undertake an environmental assessment. In order to do this, the positions and sizes of the proposed buildings would have needed to be specified in the planning application. Only the actual developer would, normally, be able to supply this information. — WJdeS.
If the clients' aim is to pass the value of the development to their children, they might consider gifting the property in its present state so that the value transferred for inheritance tax purposes is £600,000 rather than the greater value post-development. This might be a particularly attractive option if the children were going to occupy the new houses themselves so that the gain on a later disposal might be covered by the only or main residence relief by reference to the children. If a chargeable gain is anticipated in the short term, the rate of capital gains tax could be reduced to 34 per cent by using the medium of a trust. — Lacuna.
Husband and wife clients occupy a sizeable property with several acres of land with a total value in the region of £600,000. The purchase price ten years ago was £400,000. They are thinking of retiring to a smaller property and are considering a number of options in addition to the traditional sale.
It is likely that planning permission could be obtained to demolish the existing property and build three new houses which would realise significantly more than a straight sale after building costs. The alternatives being considered are as follows:
* Obtain planning permission and then sell to a developer.
* Demolish the existing property, arrange for the construction of three houses and sell them individually.
* Demolish the existing property, arrange for the construction of three houses, and give one to each of their three children.
Views are sought on the application of principal private residence relief for each case and whether there are any ways of avoiding any potential pitfalls.
(Query T15,718) — Late Developer.
Answers:
There are three main areas to consider:
Firstly, whether the private residence exemption in section 222, Taxation of Chargeable Gains Act 1992 would apply to the extent that the area of the property exceeds the permitted area of 0.5 of a hectare. Section 222(3) says the permitted area can be larger where the area is required 'for the reasonable enjoyment of the dwelling house as a residence, having regard to the size and character of the dwelling house'. The property in question is sizeable with several acres, so further consideration should be given to ensure the exemption will apply to the whole property.
Secondly, whether an application for planning permission will create a restriction in the amount of the exemption available. Section 224(3), Taxation of Chargeable Gains Act 1992 states that relief shall not apply 'in relation to a gain so far as attributable to any expenditure …. incurred wholly or partly for the purpose of realising a gain from the disposal'. Fortunately the Revenue has said that obtaining planning permission will not trigger a restriction in private residence relief (see paragraph CG 65243 of the Capital Gains Tax Manual).
Thirdly, whether principal private residence relief will be lost if the clients develop the site themselves. Section 161(1), Taxation of Chargeable Gains Act 1992 states that where an asset is appropriated to trading stock, the taxpayer will be treated as having 'disposed of the asset by selling it for its then market value'. A transfer to trading stock will therefore trigger a capital gain and also private residence relief.
Applying the above to the alternatives put forward:
* If the clients obtain planning permission and then sell to a developer, they will be able to claim private residence relief subject to a restriction depending on the size and character of the house.
* If they demolish the property and develop it themselves, they will be treated as commencing a trade of property development. The gain on the appropriation to trading stock will qualify for private residence relief depending on the size and character of the house. The profit on the property development will be taxable under Schedule D, Case I.
* If they carry out the development themselves and then gift the new houses to their children, the gift to the children will create a profit taxable under Schedule D, Case I but without the sale proceeds. Furthermore it will be a potentially exempt transfer for inheritance tax.
There are other alternatives:
* The parents could give the undeveloped plots to their children. This would reduce the value of the potentially exempt transfer and also allow the profit to be taxable on the children. If the children develop and occupy the properties, they will be able to claim private residence relief on the gain when they sell.
* The parents could set up their own property development company and sell the property to the company, leaving the proceeds outstanding on loan account. This would trigger a capital gain and the private residence exemption. The profit in the company could be extracted in a tax-efficient way by gifting shares to the children and paying dividends. (However, stamp duty would be payable on the sale to the company.) — G.S.
This is like a chess problem where two of the alternatives lead to immediate defeat by checkmate, while the other leads to victory (or at least a draw).
The exemption in section 222, Taxation of Chargeable Gains Act 1992 is for 'a dwelling-house or part of a dwelling-house which is, or has at any time in his period of ownership been, his only or main residence …'. If the main residence is demolished and replacement houses are built, it is likely that no main residence relief will be available at all. The exemption does not apply to the land on which the main residence once stood. There is no possibility of time apportionment between the period during which it did qualify (many years) and the recent non-qualifying period, as there is when the house itself is sold but has not been occupied throughout the period. The exemption is altogether lost.
The land around the house will also not qualify, unless it is the 'garden or grounds' of the main residence at the time of the disposal (Varty v Lynes [1976] STC 508).
If a single house was built to replace the original house, and the owner resumed occupation as main residence, the Revenue might accept that the main residence exemption applied to the disposal. However, if the disposal was very shortly after resuming residence, and was clearly envisaged at the time residence was resumed, then the occupation might not have the necessary degree of 'permanence' as discussed in Goodwin v Curtis, CA 1998. If three houses are built, it would clearly not be possible to occupy all three of them.
The Revenue applies the rule in section 224(3) to expenditure on actual development, for example convertinga barn into a house. So there would be a chargeable gain in relation to the expenditure in the second option, even if the Revenue accepted that some main residence relief was due. It might be possible to persuade the Revenue not to apply section 224(3) where the three houses are given away to children, because it would appear that the expenditure was incurred out of generosity rather than to realise a gain. But it is still likely that the Revenue will not accept that the relief is available at all.
Lastly, there is the question of the 'permitted area'. The legislation allows half a hectare of garden or grounds, or a larger area if it is 'required for the reasonable enjoyment of the dwelling-house … having regard to [its] size and character'. Half a hectare is about an acre; it is likely that the Revenue will want an apportionment of the gain to some of the 'several acres'. The procedure is discussed in Tax Bulletin 2.
Although it is normal for most of the value on a sale to attach to the house rather than to the grounds, in this case the house is to be demolished. If the planning permission puts the new houses in the 'non-permitted areas' (i.e. at some distance from the existing exempt main residence), the Revenue may argue that the value on sale should be apportioned simply by area. It might also argue that the cost should be apportioned on the basis of the value of land and buildings at the time of purchase, so the cost of the grounds would be a much smaller fraction of the total cost. This would again lead to a substantial chargeable gain.
In conclusion then, the demolition of the property before sale appears to lose the exemption completely. Obtaining planning permission which envisages demolition may also lead to a significant chargeable gain, unless all the new houses will be built within the area of half a hectare around the existing house. — Gardener.
Extracts from further replies received:
The first alternative, obtaining planning permission and selling to a developer while the house is still standing would still qualify for relief, subject, in the case of the surrounding land, to the limitations dictated by section 222(3). It was said in Tax Bulletin No 12 (August 1994) that it is not the Inland Revenue's practice to invoke section 224(3) where the only expenditure was on the obtaining of planning permission.
This proposal may not, however, be a viable proposition in the light of recent changes to planning law and practice. Before granting an outline consent, the local authority would need to undertake an environmental assessment. In order to do this, the positions and sizes of the proposed buildings would have needed to be specified in the planning application. Only the actual developer would, normally, be able to supply this information. — WJdeS.
If the clients' aim is to pass the value of the development to their children, they might consider gifting the property in its present state so that the value transferred for inheritance tax purposes is £600,000 rather than the greater value post-development. This might be a particularly attractive option if the children were going to occupy the new houses themselves so that the gain on a later disposal might be covered by the only or main residence relief by reference to the children. If a chargeable gain is anticipated in the short term, the rate of capital gains tax could be reduced to 34 per cent by using the medium of a trust. — Lacuna.
