Jennifer Adams outlines tax implications associated with the selling of a property below its market value.
There are various reasons why an owner sells a property at less than its market value. However, doing so can have serious tax implications, depending on the circumstances and the relationship between the buyer and seller, particularly if the sale is made to a family member.
While the intentions behind such transactions are often genuine, HMRC can compare sale prices with other similar properties, scrutinise these sales closely and use the market value as the sale proceeds instead of the actual proceeds.
'Arm’s length'
Typically, HMRC will accept the sale of a property for less than market value where the property is a main residence or a second home or buy-to-let property provided the transaction has been conducted at ‘arm’s length’.
An ‘arm's length’ transaction occurs when the sale takes place between two independent, unrelated parties, both acting in their own best interests. The property should be sold under normal market conditions, without any special agreements that influence the price. Essentially, there should be no underlying motives for the discounted sale price; any reduction must be fully acknowledged by both parties.
Note that the ‘arm’s length’ rule applies not only to property but also to any asset, such as shares or paintings.
Tax calculation
Should HMRC determine that a transaction has not been made at ‘arm’s length’, it will require an independent valuation to establish the market value.
This figure will then serve as the proceeds amount in the capital gains tax (CGT) calculation (less private residence relief and possibly lettings relief, if relevant) rather than the actual proceeds received (if any).
Selling to a family member
In transactions involving the sale of property to connected persons, HMRC will be looking to impose market value should the seller offer a ‘discount’ or the property is gifted without any expectation of payment.
HMRC’s guidance points out that a person is ‘connected’ with another if that person is:
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a ‘relative’ – brothers, sisters, ancestors, or other direct descendants;
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the spouse or civil partner of a relative;
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a relative of the individual’s spouse or civil partner; or
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the spouse or civil partner of a relative of the individual’s spouse or civil partner.
Family relations such as nephews, nieces, uncles, and aunts are not included under these rules.
A tax case illustrating the rules is Brookes v HMRC [2016] UKUT 0214 (TC). In that case, Mr Brookes sold a property to his girlfriend at cost. He argued that there was no capital gain, on the basis that the transfer was exempt because his girlfriend was his common law wife. However, the appeal failed because UK law does not recognise the concept of a common law spouse and the judge ruled that no ‘arm’s length’ transaction rule applied; it was Mr Brookes' choice to accept less than market value.
Where an asset is sold to a connected person at a loss, the usual loss relief rules do not apply. The loss may only be offset against gains arising from future disposals to the same connected person whilst they remain connected.
Selling or transferring property to a spouse
The market value rule does not apply to transfers between spouses or civil partners, whether made as a gift or reduced sale. In such scenarios, the recipient is treated as having acquired the property on the transaction date on a ‘no gain, no loss’ basis and, importantly, at the original purchase price. No charge to CGT can arise until the receiving spouse or civil partner sells the property. The transfer must be an outright gift with no conditions attached.
Where there is an inter-spouse or civil partner transfer of a principal private residence (PPR) (including properties where a PPR claim has been made), the donee is still treated as having acquired the property at the donor’s base cost ('no gain, no loss'). Additionally, any period of ownership is deemed to start not at the transfer date but at the original acquisition date by the donor. Any period during which the property was the donor's main residence is also deemed to be the ownership period for the recipient, effectively backdating the transaction.
Mortgage problem
If the property being sold is encumbered with a mortgage, UK law stipulates that should the mortgage still be in place at the time of sale, the property must be sold for no less than the amount owed on the mortgage to fulfil the mortgage obligations. This is to satisfy the requirement for the mortgage to be ‘paid off’ before the property changes hands.
If no consideration or less than market value consideration is given, the buyer may need to cover the shortfall if the agreed price is significantly lower than the mortgage.
Assuming that the seller does not need the proceeds of sale immediately, one way to mitigate the mortgage problem is for the intended buyer (e.g., a family member) to rent the property from the seller for an agreed upon period instead of selling or gifting the property. At the end of that period, the tenant can be given the option to purchase the property. The tenant-buyer pays a higher amount per month, which is used as a gradually accumulating ‘down payment’ on the property. There is usually a fee to ‘purchase’ the option, although in practice this can be as low as £1.
Stamp duty land tax
Stamp duty land tax (SDLT), Land and Buildings Transaction Tax (LBTT - Scotland) and Land Transaction Tax (LTT -Wales) is based on the price paid for the property. If no consideration is given, no SDLT/LBTT/LTT is due unless the property is mortgaged. In such cases where the buyer assumes responsibility for any existing mortgage obligations as part of the transaction, the amount of the mortgage is treated as chargeable consideration.
Nevertheless, HMRC may still impose SDLT/LBTT/LTT in certain situations, such as when the property is partially gifted or sold for a nominal amount.
Inheritance tax: Reservation of benefit rules
If the property is sold (or gifted) to a family member or someone close and the donor-seller continues to benefit (e.g., living at the property rent-free or still using the property), HMRC may apply the gift with reservation of benefit rule whereby the full market value of the property at the time of the donor's death (not just the gifted portion) is included in the estate for inheritance tax (IHT) purposes.
Pre-owned asset rules
A charge to income tax can arise (under FA 2004, Sch 15) on benefits received by a property's former owner (termed a ‘pre-owned assets’ (POAT) charge). It applies to individuals who continue to receive benefits from certain types of assets they once owned (after 17 March 1986) but have since disposed of.
If the disposal has been by way of a gift (or by selling at a less than market value price), they are potentially liable to the charge. Here, we are looking at scenarios such as a connected person buying a property for less than the market value and the donor remaining in the property they used to live in, or the cash on sale helps someone else acquire the property by contributing to its acquisition (the ‘contribution condition’).
The conditions for the POAT charge are broad, covering many situations where people continue to enjoy assets they no longer officially own.
Practical tip
In some situations, paying the POAT charge may be cheaper than keeping the cash and being charged to IHT. The POAT charge can be excluded if the transferee pays full market rent (although the transferee may need to pay income tax on the rental income).
