Future foundations: focus on property

Published on 15 August 2018

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The main residence conversion trap – could you be caught for tax?

This article is the first in a series in which we focus on property issues in our bi-monthly e-newsletter for individuals and their families, Pathfinder – personal tax and wealth (sign up here). Over the next few editions of the e-newsletter we will further explore the most common property tax issues our clients are asking us about. Whether a landlord, or simply someone looking to utilise property as an investment for their (and their family’s) future, this series will seek to advise you on your options, and prevent you from falling foul of any unforeseen tax implications!

In this first article we look at the tax issues of converting your home into separate dwellings.

If you have been considering downsizing your main residence to free up some money by splitting it into flats, then you may be surprised to learn that you could be liable to capital gains tax (CGT) or, in extreme cases, income tax.

You may think that because you own the property and you have lived in it as your principal private residence then there should be no CGT payable on disposal or conversion as this would be covered by private residence relief (PRR).

The catch here arises because there is an intention of realising a gain from the conversion.

Example:

In July 2008 Trevor acquired a large house for £100,000. The house was used as his only or main residence. In July 2012 he spent £25,000 on converting the house into two flats. He moved into one of the flats when the conversion was completed, and put the other flat up for sale. The flat was sold in January 2014 for £135,000.

H M Revenue and Customs (HMRC) advises that the value of the flat retained and the value of the freehold retained from the flat sold in January 2014 was £165,000 and that the unconverted house would have been worth £225,000.

The part of the gain which is excluded from the relief is calculated as follows:

Value of flats at January 2014 (£135k + £165k)300,000
Less
Unconverted value at January 2014
Value attributable to conversion
(225,000)
75,000
Less
Conversion costs
Net overall gain attributable to the conversion
(25,000)
55,000
Gain apportioned to flat sold:
£135,000 x £50,000 = £22,500
£300,000
The chargeable gain on the sale of this flat is £22,500.

When the flat retained as the only or main residence is finally sold, a further computation will be required as part of any gain arising on that flat may also be attributable to the conversion.

Caution should also be taken as it may be that the development and subsequent disposals could be deemed to be a trading activity and as such would be taxable under the income tax rules rather than as a capital gain. Broadly speaking, this treatment will apply where land is acquired and:

  • The sole or main object for acquiring the property or land is to realise a gain on future disposal of some or all of the land; and
  • The land is developed with the sole or main intention of realising a gain from a disposal of some or all of the developed land.

In summary, converting your home into separate dwellings could provide a nice profit but watch out for the tax consequences as the rules are complex. If you are considering this type of project then please contact us here or on +44 (0)330 124 1399 for further information.

Look out for the next property focussed article in October’s edition of Pathfinder – Personal tax and wealth update. To sign up to receive this complimentary bi-monthly newsletter, and other Kreston Reeves publications/event invitations, please click here. There is also the option to subscribe to receive our exclusive ‘property and construction’ sector updates, events and webinars for those with particular interest in this sector.

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