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Mr N, purchased a property in December 1997 at a cost of £115,000. From December 1997, his girlfriend lived at the property and subsequently, from May 1999 to April 2002, the property was rented out.
In July 2000, Mr N married Ms S and, in August 2002, he transferred the property to S at a value of £190,000, on which stamp duty of 1% was paid by S.
Mr N, purchased a property in December 1997 at a cost of £115,000. From December 1997, his girlfriend lived at the property and subsequently, from May 1999 to April 2002, the property was rented out.
In July 2000, Mr N married Ms S and, in August 2002, he transferred the property to S at a value of £190,000, on which stamp duty of 1% was paid by S.
From October 2002 to date, the property has been rented out and S has been paying the income tax on that rental income. N and S separated in May 2004 and divorced in June 2005. The market value of the property in July 2005 is £212,000.
We should be grateful for readers' views on the capital gains tax consequences of S transferring the property to N as part of divorce settlement; and N selling the property in, say, September 2005.
Are there any other tax consequences that we should be aware of? If so, any advice or planning tips from readers would be gratefully received.
Query T16,667 — Separate Ways.
Reply by Bachelor Boy:
From December 1997 to August 2002, this property was owned by Mr N with no prospect of any relief under TCGA 1992, s 223. We are not told whether the girlfriend and Ms S are one and the same, but it does not seem to matter. No election under TCGA 1992, s 222(5) appears to have been made by Mr N even assuming it was open to him to make one. We are told that it was then 'transferred' to Ms S, by (the soon to be ex-Mrs N), 'at a value of £190,000'.
Surprisingly, his then wife appears to have paid stamp duty, which indicates that there was consideration, for there would have been no stamp duty on a gift. TCGA 1992,
s 58 applies the no gain/no loss rule to this transfer. This rule cannot be disapplied and any actual consideration given is ignored for capital gains tax purposes. Therefore the wife (Ms S) has a capital gains tax basis of £115,000 plus indexation up to April 1998, which for this purpose is hardly material.
What happened to the property between August and October 2002, I wonder? Let us assume that it was empty and Mr and Mrs N were living in a matrimonial home elsewhere. It is not possible for the parties to a marriage to have more than one only or main residence between them, and in the absence of a (joint) election for the property we are concerned with to be so treated for that period, there is still no s 223 relief available (TCGA 1992, s 222(5) and s 222(6) being in point). Even if Ms S did live there, Mr N would have had to have joined in the election.
Ms S paid tax on the rental income from October 2002, which would be correct. There should be no question of HMRC seeking to attack this as 'substantially a right to income' (TA 1988, s 660A(6)). For 2004-05, they appear to have been living together as man and wife for part of the time, but not after 5 April 2005. Therefore, they will not be within TCGA 1992, s 58 (because they will not have lived together as man and wife in the year). They will still be 'connected persons' for the purposes of TCGA 1992, s 17 until they are divorced — see TCGA 1992, s 286 — so timing is critical.
We are advised that they were divorced in June 2005, but my experience is that a court will not grant the decree absolute until the financial settlement is made. As that is evidently still being discussed, I suspect that all they have at the moment is a decree nisi. This needs to be checked properly, for as I have said, in these cases, timing is crucial.
If we assume that there was a decree absolute in June, or that the transfer will be delayed until afterwards, there are three possibilities. It could still in fact be a non-arm's length transaction, at least in theory, although in my view that is unlikely in the context of divorce. Or it could be made for a consideration that cannot be valued (in which case one is back to TCGA 1992, s 17 again). Or it may be made for a valuable consideration. On any of these analyses the ex-wife will be making the disposal and will be liable for the tax and her lawyers will need to ensure that the tax she will suffer is taken into account in the context of the overall settlement. I am aware that on occasion this does get overlooked, and can lead to litigation for negligence. If it is taken into account, the effect will be to diminish the assets of both parties. A subsequent sale of the property by Mr N is not likely to have any tax consequences unless there is a delay such that the value increases. His acquisition cost is going to be the same as his ex-wife's disposal value.
I am sure — or at least I hope — that there is a moral to this story somewhere.
Reply by Lacuna:
It seems that Ms S will incur a liability to capital gains tax on the mooted disposal to Mr N. Notwithstanding the fact that the August 2002 transfer was apparently a sale (in view of the reference to stamp duty; a gift would have been exempt) the effect of TCGA 1992, s 58 is that S took on a 'no gain/no loss' basis so would have taken as her base value £115,000 plus indexation from December 1997 to April 1998. S 58 ceases to apply at the end of the tax year of separation and so is no longer in point.
The property was not S's only or main residence during her period of ownership and she would only have inherited N's period of ownership under TCGA 1992, s 222(7)(a) if it had been their only or main residence in August 2002. (It is possible that it was, as the period from April to October 2002 has not been accounted for in the query.) Extra-statutory Concession D6 (private residence exemption: separated couples) is not of assistance, as the property has not been occupied as the only or main residence of either N or S since October 2002.
One crumb of comfort is that S will inherit N's period of ownership for the purposes of calculating (non-business) capital gains tax taper relief in view of the provisions of TCGA 1992, Sch A1 para 15.
Extracts from further replies received:
As open market value is arrived at on the basis that the hypothetical purchaser is placed 'in the shoes' of the transferor and there is only a hypothetical sale, notional expenses cannot be taken into account for the purposes of computing the gain in the event of the property being transferred in specie: see Duke of Buccleuch v CIR [1967] 1 AC 506.
The only deduction permissible under TCGA 1992,
s 38(2) would be valuation and transfer expenses. But, as a sale is to take place anyway, these represent unnecessary expenditure. If, however, the arrangements were to be varied to an order for Ms S to sell the property within three months and pay the net proceeds of sale to Mr N, then the sale costs could be taken into account instead under TCGA 1992, s 38(1)(c).
