Dwelling-House Rebuilds and Flat Conversions
With the housing market reaching critical levels and the need for more affordable housing increasing, it is becoming rather popular for certain homeowners to consider either converting their homes into flats or possibly knocking down the whole house and building a block of flats or affordable housing on the plot.
There would appear to be some confusion about what taxes are involved with such a project, and conflicting advice is apparently being given in relation to the possible profits and gains.
Restriction of Income treated as a Gain
S224 Amount of Relief states that an acquisition or part acquisition will not be taxed as a gain ".. if the acquisition of, or of the interest in, the dwelling-house or the part of a dwelling house was made wholly or partly for the purpose of realising a gain from the disposal of it, and shall not apply in relation to a gain so far as attributable to any expenditure which was incurred after the beginning of the period of ownership and was incurred wholly or partly for the purpose of realising a gain from the disposal."
This section of the principal private residence (PPR) relief provisions basically enables HMRC to adjust the level of PPR available on the sale of a property that has been sold wholly or partly for the purpose of realising a gain.
Just an Extension?
The rules are in place to capture those who enhance their properties for profit, and not those who wish to improve their homes and enjoy their improvements. An example of those who would be captured would be those who build an extension and sell the property immediately to benefit from the increase in the property's value.
An even better example would be those who renovate their house into two flats. The rules do not just apply to visual changes. As per the guidance given by HMRC at CG65257, if a freehold is purchased for a flat to enhance the value of the property before sale, the profit will be captured and PPR will be restricted.
Renovation for a profit?
There are many cases where people have not renovated their properties for a profit but have been forced to sell for other reasons. If the taxpayer can prove that the motive to sell was not for profit then he should avoid the rules.
Adventure of Nature of Trade
Demolishing a house and building a new one, or flats, to sell is most likely to be "an adventure in the nature of trade" and as such any profits earned from such a venture should be taxed as a property development business.
How the capital gains and income tax would operate in such a case would be similar to the rules under s.756, and effectively the client would have a mixed CGT and income tax liability at the date the developed property was sold. Part of the income made on sale that is fairly attributable to a period before the intention to develop was formed is exempt from income tax, and therefore this would be taxed under CGT rules. This principle would not doubt be applied in the case of trade.
The property would be entered into the property development business as stock at the market value, and all costs and sales dealt with through a profit and loss account.
Principal Private Residence - the large garden
Structured correctly, disposal of part of the garden, half-a-hectare, can be tax free under the PPR rules provided it meets the "character appropriate" rules. To take full advantage of PPR on the large garden there has to be a sale for development as opposed to self development, which would be caught under CGTA 1992, s.224(3).
Buy to Let (BTL)
Many BTL owners have purchased via a mortgage where the interest and expenses exceeds the income. The negative income position leads the owner to consider that there is no need to disclose the income stream to the HMRC. This creates issues with non-disclosure, unclaimed losses and future CGT problems.
Hence if you need to discuss this with us at Power Accountax, please do not hesitate to contact us below.
Source: Tax Advisor, Feb 2008, Julie Bulter, Ian Wright (Extracted article)