There would appear to be some confusion about what taxes are involved with such a project, and conflicting advice is apparently being given in relation to the possible profits and gains. Some may say that this is a trade and taxed as income and some may say it is tax free.
What Could Be Trade?
Quite simply, if you plan to turn part of your garden into a building site to make a sizeable profit upon the sale of the new property you will most likely be deemed to be trading even if you had previously enjoyed that part of your garden as your main residence. Some may argue that a particular section of law (known as ITA 2007, s 756) may apply which converts capital gains into income gains. However, building houses for sale is a trade no matter how you try to dress it up.
There is a possible argument to say that neither a trade nor section 756 applies and a restriction to your principal private residence is due (under TCGA 1992, s 224). However, once again building a house to sell does amount to trade.
Appropriation to Stock
Should you have been deemed to have commenced trading then what actually happens is the building plot area converts from capital to stock at its market value at commencement of the trade. At this point you have technically sold part of your garden and should be covered by your principal private residence relief, and not have to pay any capital gains tax.
The eventual sale of the completed property would then be simply taxed by calculating the profit made on the development, taking the introduction of the land as an expense. In basic terms, the taxable profit would be the proceeds less value of the land introduced as stock and building costs etc. To be clear, trading profits have income tax charged rather than capital gains tax in this scenario.
In cases where a capital gain does become payable upon transfer into the business ‘appropriation to stock’ then it is possible to rollover the gain into the value of the stock and thus avoid a capital gains tax charge. This is not really advisable since the rollover reduces the stock value and hence increases the income taxable profit. With capital gains tax exemptions available and a rate of 18% compared with much higher income tax rates then this would not be a good idea.
If you continue to use and enjoy that part of your garden and you simply sell the proposed building plot, then it is possible that the sale of the plot to a builder/developer will be covered by your capital gains principal private residence relief.
Before fully relying on a tax-free disposal of the land you will need to carefully review whether principal private residence relief covers the whole of your garden. By statute you are allowed to have a garden, including your house, at a size of 1.2 acres. You are allowed to have a bigger garden than this and still get relief if your house is of a size that usually has a larger garden. HMRC considers this point by looking at the size and character of the property and do compare it to other local properties. It is of course essential that this area is used and enjoyed by the owners prior to sale.
It may be worth keeping or taking photographs of you enjoying the part of your garden you intend to sell for development. Such evidence could go a long way in convincing HMRC that you did use this part of your garden.