In this article, I would like to consider the tax implications of a scenario which may be familiar to some property owners.
Our client has owned a large family house for many years and still lives there. Some time ago, part of the property was converted into a self-contained “granny flat” at considerable expense, including installing a new bathroom and kitchen and creating a separate entrance from outside. Our client’s mother lived in the annexe for several years and, following her death, it was rented out on commercial terms to a tenant. The property is now for sale and the tenant will move out before the sale.
As part of the property has been let out, “main residence relief” (which normally operates to exempt from tax any gains made by a taxpayer on the sale of their main home) could be restricted and capital gains tax may be payable on the proportion of the gain relating to the annexe.
How will this gain be calculated?
The first step is to determine whether the annexe is a separate property or is part of the main house. If there is internal access between the house and the annexe that would suggest it is part of the main house. Separate rating for council tax purposes and separate registration with the Land Registry would be strong indictors that is a separate property.
If it is a separate property, but is sold together with the main house, then for capital gains tax purposes there are two separate disposals and the sale proceeds will need to be apportioned between the two elements on a “just and reasonable” basis, such as floor area. The costs of conversion could reasonably be claimed against the gain on the annexe as enhancement expenditure.
The next step is to decide whether main residence relief applies. The fact that granny lived there, either paying rent or not, is irrelevant. Therefore, any gain on the annexe arising since the conversion (on a time apportioned basis) is potentially exposed to capital gains tax.
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If the annexe is considered to be a separate residence, it will only qualify for relief if it is within the permitted “half hectare” (in other words, if the plot on which the house and annexe sits plus any garden sold with it is less than 0.5 hectares).
However, if the annexe could be argued to be part of the main house then the rules around outbuildings, curtilage and appurtenance must be considered in order to determine whether main residence relief will apply to the gain on the annexe. These are somewhat archaic terms and there is a large body of case law to be considered. We recommend that tax advice is taken before entering into transactions involving properties with similar complexities.
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