Malcolm Finney reminds readers of a capital gains tax ruse that no longer works.
Fortunately, for many, no capital gains tax (CGT) charge arises on a disposal of an interest in a private residence which is the disposer’s sole or main residence. However, if such a residence is let out during any period of ownership, an element of chargeable capital gain may arise (e.g. if the gain attributable to the period(s) of letting exceeds £40,000). Where the property is a buy-to-let (i.e. is let out and not occupied as a sole or main residence), any capital gain on disposal is in principle subject to a CGT charge.
Although property, whether a sole or main residence or buy to let, is typically owned by individuals it is not unusual for property to be owned by trustees. Trustees are also, like individuals, liable to capital gains tax on trust asset disposals.
‘Hold-over relief’ applies in certain circumstances, under which any capital gain that arises which would normally be subject to capital gains tax is held-over (i.e. postponed/deferred). For present purposes, if an individual owns a buy-to-let property, for example, and transfers the property to a discretionary trust, any capital gain arising on the transfer can be postponed.
Hold-over relief in practice
Example 1: transfer of buy-to-let property into trust
Herbert purchased a buy-to-let for £150,000. It has appreciated in value since the purchase to £250,000.
Herbert transfers the property to trustees of a discretionary trust and hold-over relief is claimed with respect to the capital gain of £100,000.
There is therefore no CGT charge on Herbert’s part.
Should the trustees in Example 1 at a later date appoint the buy-to-let property out to one of the beneficiaries (e.g. Herbert’s son, Tom, who lives at home with his father), any capital gain arising on the appointment could be held over; indeed, the original capital gain which was held over when the property was initially transferred into trust itself also continues to be held-over.
Example 2: transfer of the buy-to-let property to trust beneficiary
The trustees decide to appoint the property out to Tom when its value is £400,000. A claim for hold over relief is made.
The trustees were (in Example 1) regarded as having acquired the property for £150,000.
On transfer out to Tom, he is then regarded as also having acquired the property for £150,000.
The effect of Example 1 and Example 2 is that the original owner of the buy-to-let property, Herbert, is able to transfer it to his son, Tom, without any part of the overall capital gain (i.e. £400,000 less £150,000) falling subject to a CGT charge. Of course, should Tom decide to sell the property (e.g. for £475,000) he would pay capital gains tax on the gain arising on its disposal by his father, the trustees and any further gain accruing during his own ownership (i.e. on £325,000).
But if Tom decided to hold on to the property until his death, leaving it by will to, for example, his own children, the aggregate capital gain arising on the property since purchase by his father (i.e. £325,000) would be wiped out (as on death no CGT charge arises; assets held by the deceased being revalued (capital gains tax free) at their then market value).
A clever ruse…that was blocked
Herbert’s tax adviser suggests that with a bit of tweaking CGT can be avoided completely, even in the absence of death, as follows: Herbert transfers his buy-to-let into trust (as above); Tom then moves out of his father’s home into the trust property and lives in the property as his sole residence. In due course, the trustees sell the property and claim exemption from CGT on the grounds that the property was occupied by one of the trust beneficiaries as his sole residence and thus no capital gain (including the held over gain on transfer by Herbert into trust) arising on sale is subject to CGT (under TCGA 1992, s 225).
Unfortunately, since December 2003, this ‘clever’ ruse has not been possible, although in practice not all tax advisers seem aware of this. In effect, it became no longer possible to claim hold-over relief and private residence relief in these circumstances. Therefore, either hold-over relief or a claim for private residence relief only is possible. Similarly, on a transfer of the property out of the trust, a hold-over relief claim is not possible if private residence relief is claimed by the trustees. The better option will depend upon the numbers involved.
If it became clear that it would have been better not to have claimed hold-over relief on transfer into trust (but claim private residence relief instead) it is possible to revoke the hold-over claim, subject to statutory time limits.
Practical Tip:
If a tax plan looks too good to be true…it probably is.
