Replies to Queries - 2

Increasing value, increasing gain

My clients, a husband and wife, have owned their residential property for 20 years. It cost £75,000 in March 1982. It is now worth £575,000.

My clients are elderly and want to move to be near their daughter, and at the same time release some capital. But there is a hidden snag. For the first ten years of ownership, the property was wholly let while they lived elsewhere. They are now sitting on a potential gain of £500,000 (less indexation) of which only half will be relieved under the private residence exemption. Taper relief will be helpful, but not significant.

Of course, the longer these clients live in the house, the greater their proportion of the gain will be exempted. However, this is cold comfort where the value of the property is increasing significantly every year; plus, my clients are getting older.

Could readers suggest a straightforward and painless way out of this dilemma, with due regard to capital gains and inheritance tax issues?

(Query T16,137) - CES.

As stated by 'CES', the property has only been occupied for half of the period of ownership and so the amount of the gain that is exempt by reason of actual occupation as a principal private residence is 50 per cent.

Indexation allowance to be applied to the cost of £75,000 is about 104 per cent and so the gain after indexation is £422,000. At 50 per cent, the principal private residence relief is £211,000 and so this leaves a gain of £211,000 to be split between the clients. If we assume that the annual exemptions will have been used elsewhere and the clients are higher rate taxpayers, the tax payable, after taper relief at 15 per cent, is £71,740.

The first positive point to make is that the property has been let and it has been a principal private residence at some time during the clients' period of ownership. As a result, additional relief is due for each client under section 223(4), Taxation of Chargeable Gains Act 1992. One first needs to establish the proportion of the total capital gain which is attributable to the period of letting. That amount of gain is eligible for relief, being the lesser of:

As the house is jointly owned, this means that the taxable gain is reduced by £80,000 and after taper relief the tax payable is reduced to £44,540.

'CES' does not tell us why his clients did not reside in the property for the first ten years that they owned it. Were they living in job-related accommodation at another location with the intention of moving to the house at a later date? If so, section 222(8), Taxation of Chargeable Gains Act 1992 provides that the period in which the clients lived in job-related accommodation is to be treated as occupation of the house for determining the extent of the claim for principal private residence relief.

Therefore if the clients lived in job-related accommodation for the entire period from 1982 to 1992, they will be treated as having occupied the house for the entire period of ownership.

Section 223(3), Taxation of Chargeable Gains Act 1992 can also provide further relief for other specified periods of absence, but only if the house was occupied as a residence both before and after the period of absence. The query indicates that the house was not so occupied before the period of absence, unless by virtue of the fact that the clients lived in job-related accommodation, so this does not seem to be of assistance.

Assuming that no further relief is available, the clients could have a tax bill of almost £45,000. This would bring us to the potential tax benefit of delaying the sale. If the clients live in the house for another two years, the exempt fraction of the gain will be 12/22, the rate of taper relief will increase to 25 per cent and the total deduction because of letting will remain at £80,000. As a result, the tax payable at 40 per cent on the gain of £422,000 would be £33,545. This is a saving of almost £11,000, but two years is likely to be a substantial part of the clients' remaining life.

The clients will have to decide if the tax saving is worth the inconvenience of delaying the sale.

The clients do have an inheritance tax issue and the two main avenues would seem to be making full use of the nil rate band on the first death and lifetime giving out of the capital that is to be released. - Hodgy.

Although of minor help, there is also a £40,000 relief under section 223(4), Taxation of Chargeable Gains Act 1992 which can apply where at any time in the period of ownership the house has been wholly let as residential accommodation. This relief reduces the chargeable gain for the period before main residence commenced.

Incidentally, a minor help results from the rule that, in calculating the main residence relief under section 222 of the Act, the fraction of the gain qualifying for relief is enhanced because the denominator 'period of ownership' applied to the numerator 'period of occupation' is limited to the period commencing 31 March 1982, not the actual date of acquisition in that month.

One scheme would utilise the relief for the last 36 months of ownership. A lease of the property would be effected on terms which require a high rent or premium for the first three years, followed by a low rent subsequently. The clients would take some of the value of the property as income, matched by a corresponding reduction in capital values in three years' time with the main residence period extended by three years. This scheme would mitigate the chargeable gain. If both spouses (or either) have a low income, this could be worthwhile. - Lane.

Editorial note. A reply received from 'N.K.' directs attention to his reply to query T16,106 in Taxation, 7 November 2002 at page 146 which discussed a scheme involving the use of a discretionary trust. However, this would incur a prohibitive inheritance tax liability unless combined with a new Melville type scheme, in which event the artificiality of the arrangement would be all the more apparent.

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