Selling land for building: Ensuring main residence relief applies
Jennifer Adams considers the tax implications of selling part of a garden for development.
Last year (2017), the number of new homes built reached its highest level since 2008 but even so, this figure falls well short of government targets. The Mayor of London's 'London Plan' gives an indication as to how this number may be increased by imposing numerical targets for building on what is termed 'small sites' in each London borough. 'Small sites' will undoubtedly include building within the grounds of properties with large gardens.
Capital Gains Tax (CGT) will be the usual tax point on the sale of any land but in certain circumstances income tax may also be charged, as well as there being the potential of stamp duty land tax, VAT, and even inheritance tax.
If the land is not sold but the landowner undertakes the building themselves or sells to a builder and takes a proportion of the development sale profits, then this is most likely to be deemed trading, taxable under income tax. This will be the case even if the area being developed had previously been part of the garden attached to the main residence; building a house to sell amounts to 'trade'. As trading, the building plot is deemed to have been converted from capital to ‘stock’ at market value as at the commencement of trade (ITA 2007, s 756).
If the taxpayer who carries out the development is a higher rate taxpayer, consideration should be given to transferring the plot to a limited company so that the development profit is taxed at a lower rate. An election under TCGA 1992 s 161(3) treats the asset as transferred into trading stock on a 'no gain no loss' basis. However, there is always the problem of how the profits arising would be used or withdrawn from the company.
Capital Gains Tax – PPR exemption
Usually, such developments are undertaken by a professional developer, the land having been sold to them by the original owner and as such this sale has CGT rather than income tax implications. However, invariably no actual tax will be payable by the seller being covered by the principal private residence relief (PPR) under s 222 to s 226 TCGA 1992.
PPR relief is one of the more valuable exemptions in the whole of tax law as it exempts most owner-occupiers from a charge to tax. However, the exemption is not automatic.
Not only is a formal claim required but it is only available when the sale is of a “dwelling-house or part of a dwelling-house which is, or has at any time in his period of ownership been, his only or main residence” or the sale is of “land which he has for his own occupation and enjoyment with that residence as its garden or grounds up to the permitted area” ((TCGA 2006 s222 1a, 1b).
The two phrases needing further investigation are “garden and grounds” and “permitted area”.
“Garden and grounds”
It is a question of fact as to what constitutes “garden and grounds” and whether that land can be regarded as being used for the “enjoyment” of the residence; there is no legal definition.
HMRC’s guidance HS 283 “Private Residence Relief” stresses that the land should serve “chiefly for ornament or recreation”. Land let or used for a business (eg farmland) is not a “garden”, neither is land which has been “fenced or divided off from for development, or has been developed or is in the course of development (eg excavations underway for foundations, roads, services, and so on)”.
Of course, it must be stressed that HMRC's guidance is not necessarily law.
HMRC expects the garden to be used for growing plants or fruits and vegetables on a purely domestic basis. Therefore having a beehive and selling the honey at the local shop, or letting a neighbour’s animals graze on the land for a fee, for example, will give HMRC cause to deny or at least question a PPR claim as may the refusal of any kind of planning permission for the land.
This is defined as an area of up to 0.5 of a hectare (ie 1.23 acres). The area may be larger if, having regard “to the size and character of the dwelling-house, that larger area is required for the reasonable enjoyment of it as a residence”. The question to be answered is whether the house requires the land rather than whether the owner requires the land.
This section was considered in Longson v Baker 2001 (73TC415), where the taxpayer claimed that land additional to the permitted 0.5 of a hectare (used to house and graze his horses) was required for the 'reasonable enjoyment' of his dwelling house.
He contended that all of the land purchased with the property (7.56 hectares) was required, by virtue of the ‘equestrian character’ of the property. The judge disagreed, confirming that the test is objective rather than subjective. In this case, it was found not to be objectively necessary to keep horses at a house in order to enjoy the property as a residence.
In any decision under this section, the role of the District Valuer is crucial. The Valuation Office has its own method of determination which can be found at section 8 of its internal guidance manual on Capital Gains Tax: “Determining the Permitted Area and the Amount of Relief”.
Date of sale
Interestingly, S222 (1b) TCGA 1992 is written in the present tense referring to land which the owner “has for his own occupation and enjoyment”. HMRC has taken that to mean the exemption requires “ownership and occupation” at the date of sale. They have a strong case in favour of their contention in Varty v Lynes 1976 51 TC 419, where the taxpayer sold a house whilst retaining part of the garden (which was disposed of at a later date). The original sale of the house was exempt under PPR, but Mr Varty also tried to claim relief on the second sale as having been part of the main residence.
The court found that at the date of sale the land was no longer the “garden or grounds” of the property and refused relief. The judge suggested that exemption would automatically be lost in respect of the garden if the taxpayer ceases to occupy the house before being sold. However, HMRC appreciates that this view is impractical as confirmed in the Capital Gains Tax Manual at “CG64381 - Private residence relief: garden and grounds: Varty v Lynes: not resident at date of disposal”. Sometimes an owner may need to move out of the main residence before they sell, which is why the legislation allows a period of 18 months between moving out and selling the property, without any loss of the PPR; it would be unfair if this applied to the house and not the garden.
Therefore the order of sale is critical: land that is disposed of separately before the disposal of the residence may qualify for relief if the other conditions are fulfilled, but land sold separately after disposal of the residence will not qualify.
It is notoriously difficult to succeed in a PPR garden claim where the land is physically separated from the main residence, and therefore evidence (eg photographs) to support a claim will be crucial. As ever with this type of claim – each case must be taken on its merits.