Minimising Tax On Property Portfolio Sales

Alan Pink considers the tax challenges facing property portfolio owners who decide to divest, and some possible solutions.

For those property investors who are heavily geared, the spectre of an interest rate rise, at some unpredictable point in the future, is an alarming one. Others are very understandably concerned about the impact of the new restriction on loan interest relief being phased in from next April (although in many cases there are ways around this problem). 

For whatever reason, though, what follows assumes that the investor has decided to sell some or all of his properties. What, if anything, can he do about the resultant capital gains tax (CGT) liability? 

As is now generally understood, the Chancellor is continuing his vendetta against owners of buy-to-let residential property portfolios, in that he has reduced the top rate of CGT to 20% for everybody else: only the owners of residential property which isn’t the owner’s main residence, and that other physical ‘leper’, the owner of hedge fund ‘carry’ interests, is still going to be clobbered for the 28% rate. But what about properties that are part residential, part commercial (for example, the shop with flats above); and what about properties which have been used as residences for some of the period of ownership and commercially for other periods? In terms of the action available to reduce CGT on sale of property, is there any mileage in changing its use to commercial prior to the sale, if indeed that is practicable?

What we’re talking about here isn’t yet law, but it is still in the form of a Finance Bill. However, what the Finance Bill seems to be saying is that you apportion the gain appropriately. So if not all of the property has been a dwelling for all of the time, you scale down the amount of gain that is chargeable at the higher rate. 

In principle, then, there is the possibility of reducing the tax on the sale of a residential property by changing its use to commercial. However, whether this is practicable and how much of the gain you can squeeze into the 20% band by doing this will obviously depend on the circumstances of each property. 

On perhaps a more basic level, you can save tax by ensuring that there are as many as possible annual exemptions from CGT to offset against the gain. On the simplest level, a property which is owned solely by one person can be transferred into the joint names of that person and his or her spouse or civil partner. Transfers to others present more difficulty because these will tend to be taxable transfers in themselves. 

Another way of spreading the pain, of course, if you have a number of properties to dispose of, is spreading the disposals over two or more tax years, hence multiplying the number of available annual exemptions. All this may seem like small beer; however, a lot of small things can add up to a reasonably large one.

You don’t do anything just for tax planning purposes. However, if only part of the portfolio needs to be sold, it makes obvious sense to select those properties which are standing at the lowest gain.

If you are ‘lucky’ enough (in tax advisers’ parlance!) to have assets, whether part of your property portfolio or other assets such as shares, which are worth less than you paid for them, consider making disposals of these loss making assets in the same tax year as the disposals where you are making a gain: or an earlier tax year. If you aren’t actually looking to say goodbye to that asset (whatever it is) permanently, consider engineering a disposal by a transfer to a connected person, such as a trust or a relation other than spouse or civil partner. Do bear in mind, though, if you have to engineer the loss in this manner, that the loss can only be offset against future disposals to the same connected person. So the answer here might be to route your gain making sales through the same person as your loss making disposals. 

If an asset has become of ‘negligible value’, a claim can be put in to deem the asset to be disposed of at that value, crystallising the loss. What is ‘negligible’ in this context? The word out on the judicial street seems to be that asset should be worth ‘next to nothing’. So this isn’t the same as saying it has become worth, say less than 5% of its cost. The asset really has to be effectively worthless for practical purposes before a negligible value claim is competent. 

If any of the assets being sold are dwellings which have been the owner’s only or main residence at any time during the period of ownership, there are some fairly generous reliefs out there. As well as taking the proportion of the period of ownership where it was the main residence and claiming exemption on an appropriate fraction of the total gain, one can also allow the last 18 months’ ownership and a relief known as ‘letting relief’. Letting relief is up to £40,000 per owner per property, and applies where a part of the gain, which would otherwise be exposed to tax, is taxable by reason of the property being occupied by tenants. However, letting relief cannot be more than double the amount you are claiming on the basic main residence relief provisions (including the last 18 months).

So there is a planning point here which is, again where practicable, to consider adopting a property which is to be sold as your main residence for a period beforehand. Case law suggests that too short a period of occupation will be ignored by the taxman. However, on the other hand, it isn’t necessary for the property to become your actual ‘main’ residence. It could simply be an alternative residence – a second (or third) home – which you elect as your main residence. Because of the ‘last 18 month’ rule and the letting relief rule, the tax saving is out of all proportion to the actual period of use as a residence. 

Investors could consider use of the enterprise investment scheme (EIS) ‘shelter’ from CGT. Subject to a string of conditions which is too long to reproduce here, a subscription for new shares in an EIS company, which is basically a trading company that avoids conducting any of the (largely property based) ‘excluded activities’ in the list, is eligible for a type of rollover claim, under which any gain can be matched against the EIS subscription. The time limits are subscriptions up to one year before and three years after the gain making disposal. Bear in mind, too, that deferral against EIS investment is available even if the individual is ‘connected’ with the company: indeed, even if he owns all of the shares in the company. Unlike the other two reliefs which you get from EIS (which are an income tax reduction on the subscription, and ultimate CGT exemption) there is no bar to CGT deferral relief by reason of being connected. 

For the really adventurous, there is the possibility of using one of the features of ’incorporation relief’ (TCGA 1992, s 162). Where a business is incorporated in a company in exchange for shares, there is generally no gain on that incorporation. However, the company itself takes over the assets it acquires at the current value on the date of transfer. So a subsequent sale by the company, perhaps shortly after, may not give rise to any gain. 

This planning has to come with some fairly significant health warnings, though. Firstly, the relief depends on what you are transferring being termed ‘a business’. There are mixed messages on whether a residential property portfolio is a business or not, and the question ultimately must depend on a whole raft of facts. For example, how actively managed is the portfolio? How business-like is the approach of the owners to the running of the portfolio? The risk here, of course, is that, if the portfolio is not a business, CGT will arise on the transfer to the company.

Another health warning needs to be sounded with regard to transferring the portfolio into the company, and this is stamp duty land tax (SDLT). There are cases where transfers out of a ‘partnership’ to a company can avoid SDLT. However, just as there are problems with the definition of the word ‘business’, so there can be with the interpretation of the word ‘partnership’.

Finally, you also have to bear in mind that, if you transfer your business to a company and then sell some or all of the business assets later, the money is, as it were, ‘stuck’ in the company. In order to get the money out, it may be necessary to pay some or all of the tax you have saved. It all depends on what you want to do with the money once you have realised it. 

No, we don’t mean death! Death may be (indeed is) a good piece of planning as far as CGT is concerned; however, it tends to come with a rather major disadvantage (we are looking purely at the tax aspects here!) of an inheritance tax charge on the value of the portfolio. 

What we are referring to as the ultimate solution is emigration from the UK. If you become non-resident for a period of least five years, it’s still possible to sell UK assets free of CGT, and then, after this five-year interval, move back to the country if you wish. Here again, there is a rather nasty aspect to the rules which results from a recent change. Where the properties concerned are residential (and hence infected with ‘fiscal leprosy’) the sale is subject to tax even if the owner is non-resident; but only on the gain accruing after 6 April 2015. So, to take an example, supposing a property was bought in the 1980’s for £100,000, was worth £1 million on 6 April 2015 and is sold for £1,050,000 in 2016, the gain taxable on the non-resident owner is only £50,000, not £950,000.