When you sell a capital asset, you make a capital gain. The size of that gain, and thus the amount of capital gains tax you have to pay, depends on a number of factors, but at its simplest, the gain is:
- The amount you receive for selling the asset, less
- The cost to you of acquiring it in the first place, and
- The cost of any improvements you have made to the asset, and
- The costs of selling it (such as estate agent’s fees)
This article concentrates on the cost of improvements to the asset.
Not all improvement costs are allowed as a deduction. To be allowable the expenditure must have been
- Incurred ON the asset
- For the purpose of enhancing its value, and
- It must be reflected in the state of the asset at the time of the disposal
“Incurred on the asset”
The first of these conditions (“incurred on the asset”) may seem simple, and in most cases it does not cause any trouble, but consider this scenario:
Mr Wordsworth owns a valuable painting. Because his house is somewhat damp, the painting needs to be restored by a picture restorer. This costs £5,000, and the restorer recommends that Mr W should install a specialised dehumidifier on the wall near the painting to prevent the problem recurring – this costs another £1,000.
The £5,000 will be an allowable expense if Mr W sells the painting, because it was incurred “on” the painting, but the cost of the dehumidifier will not, because although the expenditure was incurred for the purpose of preserving the value of the painting, it was not incurred “on” the painting – it was incurred “on” the dehumidifier.
“For the purpose of enhancing the value of the asset”
This is self-explanatory, and again does not usually cause problems. It is the final condition that can:
“Reflected in the state or nature of the asset at the time of the disposal”
The problem here arises when an improvement to a property is no longer part of the property when it is sold:
Mr Coleridge buys a small cottage in the lake district – it is not his main residence, so he will be liable to CGT when he sells it.
He has a skylight fitted into the roof so he can enjoy the sight of the stars as he lies in bed, and he has a summerhouse built in the garden (he calls it, rather pretentiously, his “stately pleasure dome”).
A few years later, bored with the pleasure dome, he has it demolished, and replaced with a swimming pool.
When he sells the cottage, the cost of the skylight and the swimming pool will both be allowable costs, because they are both still part of the asset.
The cost of the pleasure dome, however, will not, because it is no longer part of the property. There is an argument to say that the cost of demolishing the pleasure dome is allowable – because it was part of the cost of installing the pool, assuming that the pool covers the same piece of land as the pleasure dome. If the pool is in a different part of the garden, however, neither the cost of erecting the pleasure dome, nor the cost of demolishing it again, are allowable expenses.
Not all demolition costs are not allowable:
Mr Shelley buys a barn conversion near Mr Coleridge’s – again, it is not his main residence. It used to be part of the outbuildings of a farm, and there is an old and hideous (not to say dangerous) slurry pit in one corner of the garden. Mr Shelley pays to have this filled in and turfed over. When he sells the property, this would be an allowable cost – because the expenditure on removing the pit has enhanced the value of the property, and it is still reflected in the property – in the sense that the ugly and dangerous pit is no longer there.
Finally, note that HMRC take the view that for this purpose, the date of the disposal of the asset is the date of completion, not the date contracts are signed (which is normally the date of disposal for CGT purposes). I can see no logical reason for this view, except that it provides them with another opportunity to disallow expenditure in certain circumstances.
Sometimes the owner of a property will give permission to the purchaser to enter the property and start work before the completion date of the sale. If you do this, and the work done by the purchaser includes demolishing a building you erected on the land, then the cost to you of erecting that building will no longer be allowable – because it will not be there at the completion date.