Land transactions – traps for the unwary!
With the increasing pressure on land available for building homes, it is natural for people who have “surplus land” to think about releasing some or all of this for development – perhaps by developing the land themselves, or selling the land to a third party developer.
Quite often, this land may comprise the existing home and garden or be part of the extended garden. It would be easy to assume that selling this land would be tax free under the principal private residence (PPR) rules – but this is not always the case.
The PPR rules are complex in all but the most straightforward situations – the first hurdle is to demonstrate that the property is actually a home in the first place, rather than temporary accommodation, before getting to the question of whether it is the main or only home attracting relief.
There are various anti-avoidance type provisions including a motive test – PPR relief is not available where the property was acquired wholly or partly for realising a gain, and does not apply to the gain attributable to subsequent expenditure incurred wholly or partly for the purpose of realising a gain. The latter might apply, for example, to the conversion of a house into flats.
It could well be the case that what is to be sold or developed is part of the existing grounds to the house in which case there are further tests to be considered for PPR relief. One of these is the size of the grounds. Generally, the area available for relief is limited to ½ hectare with the excess being chargeable. The sale of an undeveloped part of the garden should qualify for PPR relief if sold whilst the house is the PPR – if the house is sold first and the land later, then the land will be chargeable.
A greater area of land might be available for relief if needed for the reasonable enjoyment of the house bearing in mind the size and character of the house. However, selling off part of the land for development rather implies that it isn’t needed so that relief may not be due.
Interestingly, merely obtaining planning permission doesn’t tend to be treated by HMRC as expenditure caught above – whereas something physically done to the land or house is, for example demolition or clearing the site.
Where the genuine family home is involved, the anti-avoidance rules seek to tax the gain, not covered by relief, to capital gains tax – the current rates being 18%-28% depending on the individual’s income tax position and other gains.
However, if a person buys some other land or property with an eye to a profit, then there is a risk that HMRC could seek to charge income tax (up to 45%) instead of the capital gain tax the person was expecting. There are two prongs to this attack.
The first is that HMRC might seek to argue that what was being undertaken was in reality a “trade” and thus should be subjected to income tax and national insurance contributions accordingly. Whether or not a trade is being carried out will depend on the circumstances, there are a number of indicators that tend to be looked at – including frequency of transactions and what the person’s normal business is.
Secondly, if a trade “proper” does not exist, then there are anti-avoidance provisions which can treat a gain as arising from a notional trade and charge it to income tax. These provisions can apply, amongst other cases, where a main reason for acquiring the land or carrying out any development is to realise a profit or gain – so, again, motive is an important consideration.
An issue can also arise where there is a change in use of existing land. For example, a farmer might have been farming land for some time, but decides to develop it – either by preparing the land or carrying out building works – with the aim of subsequently selling it for profit. At the point the decision is made, the tax rules treat the land as having been moved from “fixed assets” to “trading stock” which has two important consequences.
The first is that a capital gain arises on the land at that point, even though an actual sale has not taken place, resulting in a capital gains tax charge on the difference between market value and cost. The second is that, on the sale of the developed land, an income tax charge arises. The capital gains tax charge can be avoided by electing that the gain be included with the profit chargeable to income tax – though this deferral results in a higher tax charge.
A group of people may decide to get together to promote for development land that they each hold separately. There are different ways in which this can be done, including pooling arrangements that seek to distribute sale proceeds “more fairly” with all sharing in part disposals as they take place, irrespective of whose land is actually sold at the time. These arrangements are very complex and can have particularly unusual tax consequences (with the possibility of an effective double charge to tax) depending on the arrangements used.
Land sales often include overage clauses and options to buy/sell, each of which have significant tax implications that need to be understood.
Costs of development or promotion can be considerable, with a significant amount of VAT involved. Is VAT registration required, or voluntary registration (perhaps by opting to tax land) beneficial? Stamp duty land tax may also need to be considered.
It may be that formally setting up a trade is the most appropriate way of dealing with developing land, in which case what would be the most appropriate trading vehicle e.g. a partnership or limited company? This will depend on the circumstances, but quite often a company could provide some particular benefits.
Land and property transactions are fraught with dangers for the unwary – and HMRC are now making great use of land registry information, so are better placed to pick up “casual” transactions. So it is important that anyone considering selling land or property or preparing it for sale seeks proper advice on the implications for them and what options may be available.
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