Bail-out plan for pretty riverside spot

Jan Evans
Age: 70
Lives in: Shrewsbury, Shropshire
Occupation: Retired
Mortgage: None
Debts: None
Investments: Isas, deposits, buy-to-let house
Pensions: Has state, occupational and widow's pensions
Aims: To avoid capital gains tax when she sells buy-to-let house.

Jan Evans came within a millimetre of having her home flooded last winter. She had already evacuated to the upstairs as the river touched the floorboards but the water did not quite make it over the top.

Jan moved into the house in Shrewsbury 16 months ago and knows that, sooner or later, she will be flooded: 'After I bought, but before I moved in, the water was 18 inches above the ground floor. The cellar floods regularly.'

She has already had problems finding house insurance: 'My own insurer wouldn't touch this house but the previous owners had a lot of property with Independent Insurance and leaned on them.'

Independent then collapsed: 'I managed to find another one at almost the same price but they impose a £3,000 excess.'

She does not blame insurers for refusing homes in flood-prone areas: 'The Independent had already paid out about £12,000 to the previous owners.'

She chose the area to be near one of her daughters: 'In Oxfordshire, I was an hour's drive from all three of them, which was ridiculous.'

When it is not flooding, the river is an idyllic location: 'The house is near the shops with a lovely view. I have swans and cygnets, ducks and ducklings outside.'

Jan bought it before selling her house in Oxfordshire - with help from her daugh ters. She even borrowed £3,000 from her granddaughter.

She worries that continued flood problems could make her home worthless, so she has an escape plan: 'In case I wanted to run away, I decided to buy a second house just round the corner from my daughter, so when I am 99 and need visiting daily, it will be easy.'

When she sold, she more than repaid her family and still had enough to buy the second house outright for £85,000 last summer. Until she might need it, the second house is rented out.

Now she is starting to think about the tax implications. If she sold up and moved into her second property, there would be no capital gains tax to pay. But if she abandoned the escape plan and sold the rented house, she would have to pay capital gains tax at the same rate she pays income tax: 'The property has gone up by about 50 per cent since I bought, which is lovely.'

But, she asks: 'What is the best way to hang on to future gains, if any, without a large proportion vanishing in tax?' She wonders if she could save money by setting up a limited company or by bed-and-breakfasting the property every few years as house prices rise: 'Or should I just hang on to the present house and hope the rent will bring me in a nice income?'

Adviser 1: Simon Rees

A limited company is not appropriate. They cost money to set up and run and, unless Jan owned several properties, can be tax-inefficient. Getting her money out of the company might involve further tax.

Jan could move into her rental property, elect that as her main residence and rent out her current home. As property has already increased substantially in value, there could be less capital gain when she eventually sells. Of course this may not be what she wants, and we cannot let a tax tail wag the real life dog.

In any event, gains will be at a potential capital gains tax (CGT) rate, after 10 years, of 12 per cent for a basic rate taxpayer - not bad by historical standards. On Jan's death, there will be no CGT but inheritance tax will bite as she has assets above the nil rate band of ?250,000. Jan should focus on reducing the inheritance tax bill and consider whether she wants this buy-to-let house to stay in her estate at all. Although gifting the property means she would not get the rent, it would usefully reduce the size of her estate. But a gift now could give her an immediate tax bill, so not a good idea.

Instead, why not give half the property to her daughters, which would go part way to addressing the problem without generating an immediate tax bill because of the CGT annual exemption?

Simon Rees is in the private client tax practice of PricewaterhouseCoopers.

Adviser 2: Peter Miller

Jan could sell the rented property now, secure the gains already made and eliminate any risk that they would be eroded by a house price fall.

Capital gains tax is payable less certain reliefs rather than on the total value of the property so, even if the gains were substantial, she would still keep most of them.

There may be income tax savings by forming a company but, if she transferred the property to a company now, she would pay capital gains tax on the increased value since purchase. Potentially corporation tax is payable on any company profits, income tax on any income she took and more capital gains tax when the company was liquidated.

The costs of running the company and complying with the legal and tax reporting requirements need to be taken into account. The time and the costs involved probably make it unviable.

If she keeps the property, on her death its net value is included in her estate for inheritance tax. She could avoid this if she gifts the property to beneficiaries, possibly in stages over a number of years, and survive the gift for seven years.

She could look at releasing equity from her property. Spending or gifting the money released reduces the value of her estate and her potential inheritance tax bill.

Peter Miller works for accountant Hacker Young.

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