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Residential Property - Tax Related Pitfalls to Avoid

Luke McMath

Partner Luke McMath, in our Residential Property team, provides some examples of mistakes that can be made in relation to property and tax, emphasising the value of seeking appropriate legal advice at an early stage.

It used to be said that a person was entitled to order their affairs in such a manner so as to pay as little tax as possible.  This is no longer the case, particularly since the introduction of the General Anti-Abuse Rule. 

However, it remains the case that some people order their affairs to pay more tax than was needed.  Below are some examples, based on recent requests by clients, which would have led to unfortunate taxation consequences.

Stamp Duty Land Tax (SDLT) Issues

The Loving Spouse - transfer from one spouse to joint names

Mr A wanted to transfer the matrimonial home into the name of him and his wife in consideration of his natural love and affection.  Generally speaking a gift does not attract SDLT.  However, this is often requested in relation to a mortgaged property, in which case for SDLT purposes the consideration is treated as half the amount of the mortgage debt at the time of the transfer.  With a large enough mortgage debt this can often lead the recipient of the ‘gift’ liable to a substantial amount of SDLT and this position is sometimes further exacerbated if the property is a second home meaning that an additional 3% rate will apply on the entire half value.    

The Equity Sharing Parent - purchase of an additional property

Mr and Mrs B wanted to help their child on to the property ladder.  Rather than lending a deposit they wished to take a 20% interest in the property. This is treated as an acquisition of an additional property for SDLT purposes so that additional SDLT at 3% could have been payable on the whole purchase price.

Capital Gains Tax (CGT) Issues

The Inheritance Tax Conscious Parent - gift to Child

Mrs C owned a second property which she wished to give to her daughter to lessen her estate for the purposes of inheritance tax. This is a common theme of tax planning. What is often not appreciated is that when one makes a gift of property to someone other than a spouse or civil partner, then for the purpose of capital gains tax the gift is treated as if the donor had made a disposal of the property at market value.

The Tax Efficient Spouse - transfer of a property in to joint names prior to a sale

Mr D was selling his first house which he had bought after starting work and retained as an investment property after he married and moved in to a matrimonial home.

Before the sale he wished to transfer the property in to joint names of him and his husband Mr E.   This makes use of the rules for Capital Gains Tax between spouses. The intention is that they would then both claim their personal allowances (Currently £11,300) rather than only having a single personal allowance and save Capital Gains Tax at 28% making a saving of £3164. This can be an expensive mistake.  Although spousal hold over relief applies in relation to the transfer, the recipient does not receive the benefit of the principal private residence exemption or some other reliefs which may have been claimed by the first spouse.  Mr E would have received a large capital gains tax bill.

Inheritance Tax (IHT) Issues

The Tax Avoider - gifts with reservation of benefit

Mrs F wanted to transfer her main home to her children during their lifetime in order to decrease the value of her estate for inheritance tax purposes. She wished to continue living there until she died.  HMRC is well ahead of them in this regard and with any gift which is made which you continue to derive the benefit from, inheritance tax will continue to apply as if the assets had remained within the estate.  The children though may still receive a Capital Gains Tax bill for any increase in value since the date of the “gift”. We get similar requests for the purpose of avoiding nursing home fees.  Again there are anti avoidance provisions which anticipate this.

The Helpful Estate Agent - probate valuation

Mr G was dealing with the estate of his mother. He had asked the local estate agent for a “Probate valuation” of her house. The agent, thinking he was helping, then produced a “market valuation” where he had “erred on the conservative side”. This was not an estate in which Inheritance tax was payable.  However, the valuation may have been used as the base value for the Capital Gains tax on the eventual sale meaning a Capital Gains Tax liability would be chargeable on the uplift from the probate value. Most non FRICS estate agents are not aware of the rules in providing open market valuations in probate cases.

Annual tax on enveloped developments

Mr. J has been advised to buy an investment property through a company to avoid the new rules on the loss of mortgage interest. However, no one had warned him about the annual taxes of enveloped dwellings. If the intended purchase is for a value of over £500,000.00 this can leave the company liable to SDLT at a punitive rate of 15%. This position is a risk for even properties below £500,000.00 as there is a regime which re-values properties every five years. There are some exemptions in relation to this. 

Tapering relief on a failed potentially exempt transfer

Many clients are well aware of the rule that if a gift is made and they then survive for a period of seven years then (so long as they have not continued to benefit from the asset) it will typically be considered to be outside of their estate for taxation purposes. These are known as Potentially Exempt Transfers.  What is less well understood is the tapering relief which applies to those who die within the seven year period. It is commonly believed that from the third anniversary of the gift tapering relief will apply to the value of the gift with beneficial tax consequences. In fact, tapering relief only applies in relation to tax actually payable as a result of the death so that there could be no benefit from the tapering relief unless the person has made gifts in excess of at least £325,000.00. 

The above is a selection of recent unnecessary or unexpected tax consequences which clients could have fallen foul of. Most can be worked around, given appropriate legal advice at the right (as early as possible) stage.  

For further information or legal advice, please contact Luke McMath or a member of our team.

This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.