Reducing capital gains tax on property development

Question:

My wife and I have lived in our present house for the last 10 years. This is our only UK property.

We have been granted planning permission to demolish the house and build 2 new houses on the plot. I'll be interested to find out what the capital gains tax position is in these circumstances. In particular as the house was my main residence does it apply to all of the proceeds?

I've also thought about setting up my own property company and selling the existing house to the company before the demolition.

Please can you let me know what the capital gains tax implications of this are and my best options to reduce tax?

Answer:

A dwelling house which is your main residence is exempt from CGT, as is any garden or grounds which are attached to your main residence (subject to various limits).

Therefore you could transfer/dispose of your property and the gardens (providing less than 0.5 hectare) free of any capital gains tax ('CGT') charge.

If however you were to demolish your main residence and build three new properties on the plot neither of these would be your main residence and in order to claim PPR relief, you would then need to occupy these as your main residence.

You could therefore consider occupying one or more of the properties to qualify for an exemption from PPR, however your occupation would need to be sufficient to make the property a residence.

Residence is not defined in the legislation, however the Revenue expect a degree of permanence, therefore occupation for only a handful of days each year would not constitute residence. Whilst drawn from a different context (in connection with the availability of mortgage interest relief) a Revenue extra statutory concession suggests that a period of occupation of not less than three months is required to establish a property as the only or main residence.

There are no hard and fast rules as to how long to occupy the property before it can be classed as a residence. Some commentators suggest occupying a property for a period of 12 months, although there is no fixed period set by the Revenue and they frequently refer to the 'quality' as opposed to the 'quantity'of the occupation. It is important to ensure that the residence is genuine. For example the property should be your registered address for the electoral register, and your employers should be informed of the new address.

If this was not an option you could consider becoming non UK resident before disposing of the properties. Providing your absence from the UK was for at least five complete tax years any gain would then be exempt from UK CGT. This assumes you hold the property as an investment (which should be the case).

If you are planning on remaining UK resident one option would be to as you state transfer the current property and plot to another associated entity.

This could either be a partnership (eg an LLP with you and your wife as partners) or a company. The transfer would be a market value disposal, irrespective of the agreed sale price. Therefore even if you were to gift the property a gain would arise on you (which should be eliminated by PPR relief) and the company would hold the property with a tax base cost equivalent to the market value at the date of transfer.

You would then also be subject to a further tax charge on the extraction of the funds. Dividends could be extracted tax free within the basic rate tax band, but amounts above this would be taxed at an effective 25%. Note if you sold the current property to the company for the current market value this would effectively be left outstanding as a company creditor. As such this could be repaid from the company free of any income tax charges on you.

You could consider extracting any excess proceeds over the course of a number of tax years, perhaps when other low taxable income is expected. Alternatively you could become non UK resident for a single tax year and extract cash free of UK income tax.

The best option would be to either become non UK resident or occupy at least one of the new properties as a main residence to reduce the capital gains tax charge on the disposal.

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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i) Please note that the articles/answers contain general guidance only and do not constitute accountancy, tax, investment or other professional advice.

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