Plotting to avoid capital gains tax
What happens if a garden or larger piece of ground is sold at a good profit? Does capital gains tax have to be paid? Or does the main residence exemption come to the rescue?
As we shall show, if the sale is not organised and timed properly, CGT can indeed become payable. Unnecessarily. In this article, we illustrate the circumstances in which tax relief can be lost, and recommend what should be done to prevent this. We shall start with an example of a home which stands in several acres of grounds, a country mansion. The majority of the article, however, will be concerned with more modest abodes.
The country mansion example
Mr Lucre is a Senior Director of a profitable London company. Although he uses a recently-acquired house in town occasionally during the week, he also owns a substantial country mansion in Buckinghamshire (his main home), Rolling Acres.
Rolling Acres has been Mr Lucre’s family home for several years. The grounds occupy four acres in which are situated the splendid house itself and a number of outbuildings. One day, out of the blue, Mr Lucre receives a very good offer for Rolling Acres from a titled friend. Mr Lucre has in fact himself been toying with the idea of selling the place, and this offer crystallises his thoughts of sale. The offer really is very generous and he begins to relish the prospect of a large tax-free capital gain.
Mr Lucre decides to sell. He does not, however, sell the house and grounds directly to his titled friend, as we now explain.
The neighbouring house to Rolling Acres is owned by Giles Farmer, a well-liked local landowner. Giles has often expressed interest in part of the grounds of Rolling Acres; the part being one acre of land which adjoins his property. Giles is one of those people who always keeps up with local events. He finds out about the pending sale of Rolling Acres, and he therefore asks Mr Lucre whether he would now be prepared to sell the adjoining acre.
It turns out that Mr Lucre’s titled friend agrees to the sale to Giles, as he is happy to take a somewhat reduced property (with the price adjusted accordingly!) So Mr Lucre sells the one acre to Giles. Then he sells the house and outbuildings in their reduced setting (for a reduced price) to the titled gentleman.
The sting
Mr Lucre sends in his annual self-assessment tax return in due course. He has looked at Q8 (on page 2 of the return) the question about capital gains and it is clear to him that he need only declare details of a profit made on a property if that profit is taxable (in part or in whole). Nothing to fill in there, he says to himself. Rolling Acres was my main residence and is exempt from capital gains tax.
However, the tax inspector has noted his change of address, and now asks for full details of the Rolling Acres sale. In due course, he writes to Mr Lucre saying that he will only allow the exemption for the house, outbuildings and three acres of grounds and that he intends to charge CGT on the profit Mr Lucre has made on the sale to Giles.
The rule you need to know for the grounds surrounding your main residence
Is the ground surrounding a house exempt? Mr Lucre contacts some professional advisers to find out what the law is. They tell him that the law exempts from CGT the profit on:
(a) a main residence; as well as
(b) its grounds, but only to the extent that they are required for the reasonable enjoyment of the residence. (If the whole of the grounds do not exceed half-a-hectare which is a little more than one acre they do not have to pass this test.)
Mr Lucre considers that the full four acres of grounds were quite definitely required for the reasonable enjoyment of a property of the size and character of Rolling Acres, and he sends a letter off to the Inspector of Taxes saying so. Mr Lucre’s tax inspector then plays his trump card. In his letter back to Mr Lucre, he tells him that the very fact that a part of Rolling Acres was sold to a separate buyer, and that the titled friend was content to buy the mansion with only three acres, clearly demonstrates that the full four acres were not required for the reasonable enjoyment of the house.
For larger property owners the lesson is... Don’t split your main residence — sell as a whole
In the end Mr Lucre is faced with a choice. He can either pay CGT on the land he sold to Giles, or he can enter into what will probably become a protracted and uneasy battle with the Inspector. A battle which Mr Lucre is by no means certain of winning. If only he had sold Rolling Acres as one property he probably would have been able to show that all the grounds were required for the property’s reasonable enjoyment, and he would not now be faced with this uncomfortable choice.
The lesson to be drawn from this is that readers with larger properties (that is properties over half-ahectare) should not sell part of the grounds separately if they wish to preserve their CGT exemption. Sell the property as one unit.
For those of us with more modest grounds... Up to half-a-hectare
So much for the owner of the larger property. Let’s now leave Buckinghamshire, and Rolling Acres, and check the position of the owner of a main residence and grounds of less than half-a-hectare. If you look back to the advice Mr Lucre’s professional advisers gave him on what is exempt, you will see that if the grounds of a taxpayer’s residence are not more than half-a-hectare, they are automatically within the exemption. They don’t have to pass the ‘required for enjoyment’ test.
Surely then it does not matter whether the grounds of a home of less than half-a-hectare are sold separately from the rest of the property?
Unfortunately, the answer is that it can matter very much. And the point is an important one because nowadays, with the Government encouraging us to build more and more houses, there are very many homes with surplus garden space where attractive offers are being made for part of the garden separately from the house. The rule of thumb is that if you live in a home below the half-a-hectare limit and you intend to sell the grounds (or part of the grounds) separately from the house, they must be sold before the house is sold (and not afterwards). Otherwise you will probably have to pay CGT on the profit.
The benchmark case of Varty v Lynes (1976)
The reasoning behind this strange piece of fiscal logic comes from a 1976 Court case, Varty v Lynes. What happened in that case was this. Mr Lynes owned a pleasant freehold property in Sussex known as Dalesford which he had bought in 1968 for approximately £7,000 (those were the days!). The property, which consisted of a house and grounds of less than half-a-hectare (indeed, less than one acre, the limit at that time), had been his main residence. In June 1971 Mr Lynes sold the house and part of the grounds for £10,000. The capital gain he made on this sale was completely tax-free. He retained the remaining part of the grounds.
If he had sold all of Dalesford and not retained part of the grounds the whole capital gain would similarly have been completely tax-free. But he did not do this. What he did was to obtain planning permission for the part of the grounds he had retained, and in May of the following year he sold this land for a further £10,000.
Mr Lynes claimed that his capital gain on the sale in May 1972 should be exempt from tax. The land he said was part of the grounds of his main residence, and since the house never had more than one acre of land with it, there were no tax tests to pass. (The technical reader will note here that the land had not been occupied by Mr Lynes as a main residence from June 1971 to May 1972. However, the period of nonoccupation was less than three years so that, if Mr Lynes was right, the tax exemption would be available in full and would not be time-apportioned.)
The order of sale: First the grounds then the house
Mr Varty, the Inspector of Taxes, said that Mr Lynes was wrong. You have to look at a plot of land at the point in time when it is sold to see whether it forms the grounds of a main residence, he said. If it does form part of the grounds when it is sold all well and good. If it doesn’t then there is no exemption at all. The plot Mr Lynes sold in May 1972 was not at that time part of his main residence, said Mr Varty, and therefore Mr Lynes should be charged to tax on the full capital gain on that particular plot.
Well, eventually the judge decided the case in favour of the Inland Revenue, although he conceded that his judgement could cause anomalies and perhaps injustices. How right that is!
This, then, is the reason for the advice earlier in the article that if you are below the half-a-hectare limit and you are going to sell part of your grounds separately from you main residence, sell the grounds before the house rather than the other way around. Let’s now move on to something rather different.
And if you decide to build...
Building on your own plot.
This is a real-life story, only the names have been changed!
Bertie Bucknell lived with his wife in a sizeable home which stood in nearly three-quarters of an acre of ground. The children had grown up and flown the nest, and Mum and Dad were beginning to find the home and garden rather too large for their needs. Bertie was fortunate in that he was able to obtain planning permission to build a new home at the bottom of the garden. He and his wife resolved to build the new home (or to be precise to get someone to build it for them) and to move into it. They would then sell their existing larger home.
Having built the new house in the grounds the missus didn’t want to move in!
However, when the new home was all but complete Mrs Bucknell changed her mind. She decided she would prefer to stay in the home in which she had raised her family. As it now stood in well under half an acre of ground, the property would no longer be too large for them. However, Bertie preferred the new house, which had been architect-designed to his own specification.
The judgement of Solomon was required to resolve the difference between them. Solomon, in this case, turned out to be their accountant. He advised that;
- if they sold their present home, the profit on the sale would be exempt from tax; but
- if instead they sold the new house, the profit would be caught in the tax net.
A sale of the existing home would be exempt because it was their main residence. However, the new house would not qualify for this exemption as Mr and Mrs Bucknell had never lived in it.
The rule here on main residence is...
So Bertie won the day. The rule is: if you build a house and want any profit on sale to be tax-free, you must move into it so it becomes your main residence.
It doesn’t matter if you find, after a few months, that you do not like it and decide to move on. Mr and Mrs Bucknell could sell their old family home this month, move into the new house, and then sell it early next year. The profit on both houses (including the quite substantial development profit arising on the new home) should be entirely free of tax.
Here’s a summary of the tax planning messages which we have highlighted here on the subject of gardens and grounds.
What to do when you find there are profits at the bottom of your garden
Many lucky people find that one of the biggest windfalls of their lives comes from the sale of part of their garden. The sale will usually be to someone who will build a house on it or perhaps the owner will first build the house and then sell. In order to escape tax on the profit, the following guidelines should be followed.
- If your property extends to more than half-ahectare, don’t sell off a part of it. Sell the whole property at once. (Even then, the taxman may argue that part of the land was not required for the enjoyment of the home, but at least you haven’t handed victory to him on a plate.)
- If your home and garden does not exceed the above limit, you can sell off part of it tax-free. But sell the plot before you sell the house, not vice versa.
- If you build a new home in your existing grounds, you must do so with the intention of living in it as your ‘main residence’. And you must carry out this intention.
Finally, a court interpretation of ‘reasonable enjoyment’?
We said earlier that even where the property extends to more than half-a-hectare the CGT exemption still applies provided that the additional grounds are required for the reasonable enjoyment of the house.
But, of course, what constitutes reasonable enjoyment here might mean one thing to me and something very different to you and different again to the Revenue.
Here’s how, in practice, the Courts fairly recently interpreted the meaning of reasonable enjoyment.
A homeowner, Mr Longson, sought to get an area of grounds amounting to some 18 acres treated as falling within the main residence exemption. (In new money or at least in metric money 18 acres is about seven hectares.) The reason, he explained, was that he kept horses (with stabling, etc); and that he therefore needed all of the land for the reasonable enjoyment of the home because of the equestrian interests of himself and of his family whilst living in the property.
Nice try. But sadly, the Court rejected his argument. The extent of the tax-exempt area could not vary from owner to owner, depending on their particular leisure interests. The home itself could reasonably be enjoyed as a residence without the equestrian activities, and Mr Longson’s claim was therefore rejected.
As we showed earlier, the one plus acre limit can sometimes be extended, but rarely are the Revenue (and the Courts) likely to sanction as much as 18 acres!
Robert Bond has been a practising chartered accountant for 20 years.
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