CGT or IT or both on sale of rental property?

CGT or IT or both on sale of rental property?

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Client bought a house and converted it into two flats. The flats have been rented for 10 years. Client is now converting back to a house prior to sale. His 'friend' has said that there will be income tax on the sale as client is converting to enhance its value and hence make a profit! Surely the whole scenario is one of a CGT flavour? Any thoughts please?

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By Phil Rees
09th Sep 2013 15:31

That depends

If he is a builder by trade, or if he has done this sort of thing before, then it will probably be treated as trading. This of course gives you a problem with valuation.

If it is a one-off then CGT treatment will probably be appropriate.

 

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By Steve Kesby
10th Sep 2013 11:09

There's potential (and perhaps desirability) for both

I do agree with Phil that, in these circumstances, a conversion in order to maximise the return on disposal is unlikely to be sufficient to render it trading of itself.

If you treated it as trading though, HMRC would be unlikely to argue, and there might be advantages in doing so.

If you treat it all as CGT, you won't get any tax relief for the original conversion into flats, because the effect of the expenditure won't be reflected in the state of the asset at the time of disposal.

The same is also arguable of the subsequent conversion back to a house, to the extent that it simply restores the asset to the state that it was in when acquired.

However, if you treat it as a trade, it's only a trade from the time that the intention to develop it was formed. Prior to that it was CGT and you get a deemed CGT disposal at market value at that time.

From that deemed disposal you can then deduct the original conversion costs. The resulting gain can then, effectively be held-over (under S.161 TCGA 1992) into the base cost of the trade.

Within the trade the costs of conversion back to a house will then be fully allowable.

So by paying an additional 12%-17% tax on a portion of the gain may ensure that you get full relief for all of the (start and end) conversion costs. It's worth performing a calculation to see which is best.

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By gbuckell
10th Sep 2013 15:47

Addendum

To add to Steve's excellent reply, I think he means that you do not elect to hold over the gain under s161 otherwise the whole gain will be liable to income tax.

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By Steve Kesby
10th Sep 2013 16:11

More erratum

Thanks Graham. I was happily making an election under S. 161(3) to defer tax on the gain, overlooking that in doing so it would then be taxed as income as well. You're quite correct the election should not be made.

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