Tax on property gains: Some planning ideas

Alan Pink picks out some lesser-known possibilities for reducing capital gains tax on property.

 

It’s a longstanding, and in my view justified, complaint on the part of property investors that they are taxed on inflation. In fact, since the abolition of capital gains tax (CGT) indexation allowance a few years back, the whole of CGT has been a tax on inflation, as well as a tax on ‘real’ gains; it’s just that this has a much more marked an effect where you’re talking about property, which historically has had a rate of inflation far in excess of anything that you will find in the retail prices index. 

 

The effect of taxing inflation, of course, is that there is a strong disincentive to sell one property and buy another; because the replacement property you will be able to afford (after tax) will usually be a significantly less valuable one. 

 

In this context, it seemed to me that it would be useful to look at some ways in which this scourge of property owners could be mitigated.

 

In what follows, I’m not going to attempt to be comprehensive; there are many and varied ways of reducing CGT, which it would take a whole book to do justice to. But the three tax planning ideas that follow are all ones which I have seen work well in practice, and pass the ‘prudence’ test of being what you would describe as sensible tax planning rather than aggressive ‘schemes’. 

 

The rate of CGT on the sale of residential property will generally work out at 28%, with that on commercial property being 20%. But these rates apply to gains which exceed a person’s CGT annual exemption (currently £12,000), and which are received by individuals who are higher rate income taxpayers. Of course, a gain of any size is likely to put somebody who would otherwise have been a basic rate taxpayer into the higher rate, but the point here is that ‘many hands make light work’; or rather, transferring this into the tax sphere, many owners make lower rates. 

 

The sooner this obvious principle is appreciated in the lifetime of a property investment, the better. If you’re on the point of selling a property which you own in your sole name at a large gain it’s a bit late, all things considered, to think about sharing the ownership of this property amongst your family. A straightforward gift of a share in the property will itself give rise to the capital gain you are fearing, on a proportionately reduced amount. So, the ideal situation, if you foresee the likelihood of a sale of a property in the future at a gain, is to put it in as many different names within your family and household as is consistent with what you want to achieve in your financial life.

 

One neat way of achieving this is to have a family investment LLP. Let’s take an example. 

 

John and Mary are married and have three children, aged 20, 16, and 11. They decide to invest in property and acquire a small flat to start off the portfolio for £100,000. Instead of simply owning this in the joint names of John and Mary, though, they form a limited liability partnership (LLP) to acquire the property, in which all five of the family are members. 

 

A few years later, they sell the property for £150,000, but the gain of £50,000 is tax-free because the LLP agreement allocates it equally between the five members, so as to be within each person’s annual CGT exemption.

 

You’ll notice that, interestingly, there’s no provision in CGT, as there is in income tax, to tax gains made by minors (people under 18) on their parents. 

 

For those who haven’t thought ahead and planned in the way that John and Mary did in my example, there are some circumstances where you can share out ownership of assets after they have been acquired and increased in value, without that sharing out itself triggering tax on the gain. 

 

Firstly, and most obviously, transfers between spouses and civil partners are CGT-free, being treated as made at such value as gives rise to neither a gain or a loss. It’s also possible to give properties to trusts, with hold over relief generally being available even if the property is not a ‘trading’ one – with a subsequent transfer out of the trust of the asset to a beneficiary, again with hold over relief. However, the use of trusts is strictly circumscribed by the inheritance tax lifetime charge at 20%, which applies where the cumulative value of your transfers into trust over the last seven years exceed the nil rate band (currently £325,000). 

 

Tax planning using furnished holiday lettings (FHLs) has had its wings clipped recently, but generally speaking, the CGT advantages of this particular type of property investment, which is treated as a trade for CGT purposes, are still intact. 

 

A reminder of the requirements; to qualify, a property must be available for short term letting as holiday accommodation for a period of at least 210 days a year, and must be actually so let for at least 105 days. If it meets these criteria, it will be treated as an asset of a trade and, importantly for our purposes, entrepreneurs’ relief is in principle available. Let’s have another example.

 

Bob has owned a flat in Central London for ten years and has seen it double in value in that time. For various reasons, he decides to sell the flat and realise the significant gain in value. Until now, the property has been let to a single tenant on renewed assured shorthold tenancies. However, the tenant is now planning to move out, and Bob makes the decision to operate and market the flat as accommodation for holidaymakers. 

 

Due to its location, the flat lets itself and Bob is in a position, after two years, to sell the flat and claim entrepreneurs’ relief on the whole gain. In this way, he reduces the tax charge on that gain (which has accrued over twelve years) from 28% to 10%.

 

An interesting fact to note about the above example is that entrepreneurs’ relief is available even though the conditions are only met for the two years prior to sale. 

 

Still on the subject of entrepreneurs’ relief (which applies, of course, only to assets used for a trade), one unfortunate feature of the relief (which replaced business asset taper relief in 2008) is that it’s only available for the sale of a business and not for the sale of individual assets, even if those have been used in a trading business. 

 

The following example illustrates this; and offers an idea for how the problem can be got around in some circumstances.

 

Mr Giles is a farmer who owns the three hundred acres (plus farmhouse and buildings) that he farms. One large field, which adjoins a growing town, is granted planning permission for residential development. As a result, the value of the land shoots up from the agricultural value of £8,000 per acre to development value of £1 million per acre. 

 

Mr Giles goes to see his accountant to get an idea of how much tax he’s likely to pay. The farm as a whole was acquired by him not so long ago, at a time when the agricultural value was also £8,000 per acre, so there’s no gain on any of the farm except for the six acres which have planning permission. 

 

Mr Giles is disappointed to hear from the accountant that he’ll be paying 20% tax, not 10%, on the sale; given the numbers that’s an extra £600,000 tax. The reason is that entrepreneurs’ relief isn’t available. This would only apply if Mr Giles were selling the whole business or a recognisable part of the business. As it is, selling one field won’t make a lot of difference to the business which remains on the other 294 acres.

 

So, the accountant hatches the following plan. Mr Giles takes his son Jack into partnership, and the partnership agreement provides that Jack will be entitled to 100% of all capital gains in future. The result of this (because of the way partnership CGT works) is that Mr Giles is treated as making a disposal of the whole of the business to his son, at market value. The son then takes over the base cost including a base cost for the development land at £6 million, and Mr Giles pays tax at 10% with the benefit of entrepreneurs’ relief – because he’s now disposing of a business and not just business assets.

 

Of course, the above is only one sort of situation where this principle applies; and the solution is only one way in which a disposal of the whole business, to bring it within entrepreneurs’ relief, can be brought about.