The Spending Review detailed last month underlined the fact that the Government needs to find extra money from somewhere. HMRC is already rallying to the cause by targeting landlords and second home owners reviewing many Capital Gains Tax (CGT) calculations on property sales, specifically asking for justification of the figures used.
Thus if it cannot be proved that a particular expense was incurred that would normally be allowable, the HM Revenue and Customs (HMRC) could seek to disallow the amount claimed which potentially could prove very costly for the seller. A record therefore needs to be kept of each expense which is obviously easier to do at the date incurred rather than years after the event.
Initially HMRC used the Land Registry records plus the website ‘Rightmove’ to identify owners who had sold CGT chargeable properties but had not told the taxman. However, it has been noticed that they are taking the search further by linking computer systems and checking the self-assessment tax returns of landlords and second-home owners who had correctly declared that a sale had taken place but had either claimed expense deductions twice, once against rental income and again as a capital expense in the CGT calculation or had made a claim for a capital expense when it was not.
• Repairs and Maintenance costs incurred to an existing part of a property (for example decorating) are allowed but as an income expense rather than a capital expense. Some landlords would incorrectly try to claim such an expense as capital if the rental accounts showed a loss and were unable to obtain income tax relief thereon.
• Any improvement or enhancement cost that adds to the value of the property which is still present at the time of sale is allowed as a capital expense. Such costs would be, for example, for loft conversions, extensions, a new conservatory or the building of a garage. The HMRC website gives the example of allowing the cost of a swimming pool installed as adding value to the property but insisting that the pool be still available for use on sale and not having been filled in.
Specifically What Costs are Allowable in a CGT calculation?
• Purchase price or 31 March 1982 valuation;
• Stamp Duty Land Tax paid;
• Acquisition or sale costs plus VAT thereon i.e. fees paid for professional advice including agents’ commission fees, survey costs, conveyance fees and valuation fees. Such expenses incurred in connection with the first letting of a property for more than one year are deemed a capital expense and are therefore allowable. (See HMRC Property Income Manual at PIM2205 – Deductions: Specific Items (www.hmrc.gov.uk/manuals/pimmanual/pim2205.htm)). Such expenses for a let of a year or less are deductible as an income expense against rents received for that year; and
• Improvement costs;
Purchase Price or 31 March Valuation Figure – Which to Use?
If the property was purchased post 31 March 1982, the amount to be used is the purchase price, and records will therefore need to prove the original cost of the asset; usually this will be included on the contract of sale or Title Deeds if the property was purchased post 2000.
If the property was not purchased but rather was obtained via an inheritance or gift, records will need to confirm the valuation at the date of the inheritance or gift. For example, a property inherited from a deceased relative may have been valued for Inheritance tax purposes as part of the relative’s estate on death.
If the property was acquired pre 31 March 1982 then the market value as at that date is used instead of the actual purchase price plus any improvement costs to that date. If no valuation figure has been kept, the HMRC Inspectors are under strict instructions to refer all such property cases to the District Valuer, who will make his own judgement based on records of sales made at the time and taking local factors into account.
The resultant figure will generally be low (making the capital gain high), therefore if you are in that situation it may well be worth the cost (which is tax deductible!) of engaging a respected local surveyor prepared to not only determine an independent 31 March 1982 valuation but also to defend his findings against the figure put forward by the District Valuer, if necessary.
HMRC will often take more notice of a valuation made nearer the date of sale rather than one made earlier. Further detail as to how valuations are calculated can be found on the Valuation Office Agency website at http://www.voa.gov.uk/publications/property_market_report/1982/Index.shtml
What Does HMRC Say?
HMRC acknowledges the importance of record keeping in its ‘Capital Gains Tax for Land and Buildings Toolkit’ specifically identifying ‘poorly kept records’ as a risk for Enquiry (see http://www.hmrc.gov.uk/agents/toolkits/cgt-land-buildings.pdf page 5).
HMRC recommends that the following documents be kept:
• actual contracts for the purchase and sale, lease or exchange of the property
• any documentation that describes properties acquired but not purchased, for example, by a gift or inheritance
• details of any property given away or placed into a trust
• copies of any valuations used in the CGT calculation
• bills, invoices or other evidence of payment records such as bank statements and cheque stubs for costs claimed for the purchase, improvement or sale of the property
What Happens if You do not Have the Documents to Support the Expense Claim?
A claim is still possible even without the paperwork although it will not be as easy to prove with; you will need to record the thinking behind the calculation. If a 31 March 1982 valuation is not available, one will be required. Keeping all relevant papers will make the calculation easier to make and may prove invaluable should the Revenue issue an Enquiry Notice and you be called upon to prove the figures declared on the Tax Return.
The declaration of the Capital Gain on the sale of a property is made on the Self Assessment tax return. Under Self Assessment the law requires taxpayers to keep and preserve the records needed to make a correct and complete return until the end of the Enquiry window which is the first anniversary of the 31st January next following the year of assessment.
Therefore for the 2009-10 tax return filed by the filing date of 31 January 2011 records should normally be kept until 31 January 2012 (or until 31 January 2016 if the taxpayer is self-employed or in a partnership).
However, it would be advisable to keep any records relating to the purchase or improvement of a property until, say, 15 months following the tax year in which the property is sold in case you are called upon to prove the figures declared.
By Jennifer Adams