Alan Pink looks at some of the tax complications that can arise when transferring the ownership of property from one person to another.
You could write a book about the tax implications of transferring real property from one person to another; but not many people would have the time to read it. Instead, I am hoping that a very rapid resumé of some of the big issues might help avoid problems, and/or seize tax planning opportunities which might exist.
You wouldn’t be far wrong if you adopted the general principle that you should consider every possible tax, at least in principle, before signing that lease or transfer form TR1. As an overview, you should consider not just the possible tax charge which could arise as a result of the transfer itself, but also the tax-efficiency of the situation following the transfer, in cases where we are talking about moving property between connected persons. Let’s look at it on a tax-by-tax basis:
1. Capital gains tax
This is obviously the tax which springs to mind first when considering disposals of property from one person to another. Perhaps the biggest, and most obvious, tax ‘trap’ is that transfers of property at an undervalue, or by way of gift, can still give rise to capital gains tax (CGT). Such transfers are deemed, for the purposes of the tax, to take place at such value as the property would fetch if sold on the open market at the date of the disposal. So, if you give an investment property to your son, for example, you could end up with a nasty surprise in the form of a tax charge some time later. Such transfers are fine, of course, if they are of exempt assets, such as a property which has been your main residence throughout your period of ownership; and they can generally also be made tax free as a result of ‘holdover relief’ if they are business assets (for example property used for a trade that you carry on) or are gifts of property into trust.
But, do bear in mind always the potential application of CGT when making any kind of disposal or transfer of property.
2. Stamp duty land tax
This article focuses on stamp duty land tax (SDLT), but it is also important to consider land and buildings transaction tax in Scotland, or (from April 2018) land transaction tax in Wales. SDLT is much more of a menace now than it ever used to be. When stamp duty was at a flat rate of 1%, it was a tax you could almost forget about – and it wasn’t that long ago. Governments have recently seen the potential of property as a new source of revenue, though, because property by its nature can’t be moved offshore and transactions in property are very visible. Also, the government has been very keen recently to try and modify our behaviour by imposing substantial SDLT charges.
Generally, the SDLT rules are quite well understood, however, there is one particular trap which I feel needs highlighting. Let’s illustrate this by way of an example.
Mr A owns an investment property worth £1 million, on which there is a £600,000 mortgage. Being a higher rate income taxpayer, and his wife having very little income, he decides to transfer the property to her. The building society agrees to transfer the property, and the mortgage, on condition that he guarantees its repayment in accordance with its terms and goes on the books as a joint owner. This isn’t too much of a problem from Mr A’s point of view and the point of view of his income tax planning, because he can execute a deed of trust under which his interest is minimal, and so the bulk of the income goes to his wife, thus utilising her personal allowance and lower income tax band.
Mr A is aware of the rule that, unlike any other gift of assets, a gift to one’s spouse (or civil partner) is normally exempt from CGT.
But, what he has forgotten is the fact that, by taking over the liability on the mortgage, or a share of the mortgage, Mrs A is treated as giving ‘consideration’ for the transfer of the property to her for SDLT purposes. Assuming she’s taking over, effectively, near enough 100% of the relevant asset and liability, she’s treated as paying £600,000 for the property, and a very large SDLT bill is the result. There’s no exemption for transfers of property between spouses as far as SDLT is concerned.
To avoid this issue, and still achieve the desirable income tax benefits and CGT exemption, Mr A could consider forming a family investment LLP with his wife and introducing the property into that. Unlike the position with a straightforward transfer of ownership from one person to another, the introduction of property into an LLP in which all the members are ‘connected’ is governed by special rules, which provide that the chargeable consideration for the transfer into the LLP is generally zero.
3. Inheritance tax
The first thing to say here is that, if you have decided to avoid paying CGT on a gift of property by giving it into trust (see above) there is a potential huge downside in the possible incidence of inheritance tax (IHT). An individual can only put fully chargeable property (such as a buy-to-let investment property) worth up to £325,000 into trust, over a seven-year period, before the tax charge arises at a rate of 20% (the lifetime rate).
Sometimes, there can be a bit of a numerical ‘balancing act’ between CGT and IHT. As in this example:
Mr B has a property in Bristol, which cost him £300,000 and is now worth £500,000. No mortgage is secured on the property. He wants to give the property to his son, but doesn’t want to pay CGT on the £200,000 gain that he would be deemed to make. So, he decides to give the property to a trust for his son, which is the next best thing. It takes the property out of his estate, and provides a real benefit for the son, who can receive payments of the rental income as his own.
The problem is that a straightforward transfer of the property to a trust would trigger IHT which, even if Mr B hasn’t made any transfers into trust in the last seven years, would still be a substantial sum; in fact, it would be £500,000 minus £325,000 at 20%, that is a fairly swingeing £35,000 tax charge. If he sells the property to the trust at market value, rather than giving it to the trust, this would eliminate the IHT charge but would give rise to CGT – because you can’t ‘hold over’ a gain when you have actually realised this in money terms, only when there is a gift.
So, the balancing act in this instance comprised Mr B selling the property to the trust, not for £500,000, but for £175,000. That way the ‘bounty’ he’s conferring on the trust is restricted to the £325,000 value which is within his available IHT nil rate band. At the same time, the whole gain can be ‘held over’ for CGT purposes because Mr B has ‘received’ a sum which is less than his original base cost for the property.
Incidentally, reducing the actual price tag placed on the transfer to the trust to the minimum in this way also minimises the SDLT, which inevitably arises on any sale of a property where there is actual consideration, as here.
4. Taxes on income
Property transfers can be relevant for income tax (and corporation tax on income) purposes, where, for example, the property concerned has been used for a trade and capital allowances have been claimed on any element of it. The trap to watch out for here is the potential clawback of these capital allowances if the amount received for the fixtures, etc., is more than the balance to which you have written down the fixtures ‘pool’. This is often overlooked on sales of property to third parties until a late stage of the negotiations. With transfers between connected persons as defined, however, there is the possibility of electing for the tax written down value to be used, thus avoiding any charge to ‘income’.
Arguably this should have perhaps come first because VAT is probably the biggest headache of them all in transferring a property and should always be considered at an early stage of negotiations.
To get the easy situation out of the way first, any property which is residential in nature, and is more than three years old, is exempt from VAT. So, this means that you’ve no problem with charges to the tax ‘coming out of the woodwork’. The worst that can happen to you is that the VAT on the professional charges, for example, your solicitor and estate agent, relating to the sale will be disallowed even if otherwise you are a fully VAT registered person.
Commercial properties, on the other hand, are subject to VAT if they are less than three years old; and this certainly is a situation where very large and very expensive errors occur in practice. Worst still is the position where a property is perhaps considerably older than that, but somewhere in the past has been made the subject of an ‘option to tax’. An option to tax applies to a property forever (although it can be revoked after 20 years) where it has been made, and so the result is that, even if you haven’t been letting out the property and charging VAT on the rents, the effect of the option is that a VAT charge arises on the amount you receive for the sale of such a commercial property.
This can be a financial disaster if, for example, the situation (i.e. the existence of the option) isn’t identified until after the property has been sold and all the completion accounting done by the solicitors. The rule states that, if a contract is silent on VAT, whatever amount you receive under the contract includes any VAT there may be.
So, imagine the situation of a person who sells a property in Manchester for £1.2 million, where the contract doesn’t mention VAT. Let’s suppose that HMRC come along after the event (as they are so prone to do) and point out that they have on their records an election to charge VAT dating back many years. The effect is that HMRC send a bill for £200,000, being the VAT on a gross figure of £1.2 million, and this is a dead loss for the seller.
A problem which arises even more frequently in practice than this is where the question of VAT is not considered by the purchaser until a late stage – often because he didn’t know that the current owner has an option to tax in place. So, if he’s looking at buying a property for say £1 million, he suddenly finds that the amount of money he actually needs to pay to the vendor is £1.2 million. This can be awkward, to put it mildly, if he is financing the purchase and only has the money available to pay £1 million on completion. Moreover, the SDLT on the purchase will now be on the £1.2 million figure, not on £1 million because this is an instance of ‘tax on tax’.
There is a ‘clever’ way to get around this last-minute conundrum, and it involves bringing about the position that the transfer of the property is the transfer of a ‘going concern’. If the vendor is a landlord, letting the property with VAT on top of the rents, the purchaser needs to structure things such that he too is a landlord (even if the real commercial purpose of the acquisition is to use the property for his own trade). By setting up a separate landlord entity, such as an LLP, he can bring into play the transfer of going concern rules, which mean that VAT is not charged on the transfer. The result: he can get away with paying only the £1 million (in our example) he had originally agreed as the purchase price; and he also saves the extra SDLT into the bargain.