Author: Charles de Lastic

Make sure you don’t lose private residence relief if you work from home

Working from home is growing in popularity.  However, have you considered if it could affect your Capital Gains Tax (CGT) private residence relief when you come to sell?

One of the best known tax reliefs, private residence relief allows a person to sell their main home without triggering a liability to CGT.  When someone owns more than one residential property, you can choose which one is the main residence for the purposes of the relief.  It does not have to be the one in which you spend most time in and you change which property is regarded as your main residence, although only one can be the main residence at any one time.

Relief from CGT is given on the disposal of all or part of a qualifying property.

Private residence relief is not available in respect of any part of the property that is used exclusively for business use.  Relief is denied for that part of the property that is used exclusively for business use.  Therefore, where there is exclusive business use, any gain on the sale of the property must be allocated and the proportion on the area relating to exclusive business is subject to tax.

For example, if I run a graphic design business from home.  My house has seven rooms and I use one exclusively as an office.  On the sale of my property, I receive a gain of £40,000.  One seventh (£5714) of that will be subject to CGT.  As my annual exemption (£10,100 for 2010/11) remains available, the gain will be sheltered and the result is that no CGT is payable.

The same applies for people who are employed workers but work from home and set aside a dedicated area exclusively for work.

Relief is only lost where there is exclusive business use of part of the property.  To protect the exemption, all that is necessary is to ensure that any part of the home that is used for business purposes is also available for private use.  For example, a room used as an office during the day could also be used by the taxpayer’s children to do their homework in the evening.

By making rooms used for business purposes also available for domestic use, it is possible to work from home and ensure that private residence relief remains available for the whole property.

Non-exclusive business is a ‘good thing’ for protecting the full entitlement to private residence relief; however, the same cannot be said for income tax.  Relief for expenses is available to the when they are incurred wholly and exclusively in relation to that business.  Where a room is used exclusively for business, a greater deduction is permitted.  Where the use is non-exclusive, the permitted deduction is reduced as costs must be allocated between business and domestic use.

In summary

If part of the property is used exclusively for business, all is not lost from a CGT perspective.  Depending on the amount of any gain in relation to the business part, it may be possible to shelter the gain with the annual CGT exemption.  This makes it possible to use part of your house exclusively for business and to sell the house without paying any CGT, while enjoying the maximum possible deduction for expenses in the process.

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Inflation rises

CPI annual inflation – the Government’s target measure – was 3.7% in April, up from 3.4% in March.  The largest factors to the change in the CPI annual rate between March and April came from the rise in prices for clothing and footwear, food and non-alcoholic beverages and alcoholic beverages and tobacco.

Is it a good thing, or a bad thing?

Certainly, not everyone is concerned about the recent rise.  Some homeowners are even welcoming it thinking that it will lower the value of their debt and lessen the burden on them in the future.

This could be a mistake.  It is true that in theory, inflation may erode the real value of the debt.  However, it can’t reduce the monthly burden of the debt unless wages are rising too, and they are not.  We know that the government is planning a freeze on all public sector salaries above £100,000, but it isn’t just the very well paid who are likely to see their nominal wages stay still and their real wages fall.

The retail price index may be rising at over 5% a year, but it is not likely that the tax-paying public will agree to a nominal wage rise of 5%+ for any public sector workers.  That suggests that real wages for the millions of people who are dependant on public sector money are on the way down.

It’s the same for the private sector.  Unemployment is high and rising and there is little or no pressure on companies to offer higher wages than they already are.  Statistics show that real wages in the private sector are also coming down.

What is inflation actually doing for those people with debt?  Their cost of living has risen (via rising oil and food prices), thus leaving less money for interest and debt payments.  So, the higher it goes the more of a burden the debt becomes – not the other way round.

It might work the other way for small business owners if they can raise prices whilst keeping real wages down. 

If you have debt, via your mortgage and credit cards, please don’t think that today’s inflation rate might be good for you  as it probably won’t be!  Contact an experienced independent financial planner if you think you need help and financial advice.

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House price surprise

It’s no surprise to hear that the country’s finances are ‘in a mess’.  It is surprising to learn that house prices continued to rise in May and are now just 9.5% below the October 2007 peak, according to figures from Nationwide.

This is more surprising as a higher unemployment level is usually bad for house prices.  When people lose their jobs, they find it difficult to keep their homes.  Higher repossessions and worsening bad debts for banks is one reason why the banks don’t want to lend money to lots of people now. 

So, why are house prices still rising?  Basically, the number of sellers has dropped, increasing competition between buyers for those properties on the market. 

This situation is unlikely to last.  As more sellers join the market, prices will begin to drop.  Depending on the timing of the coalition government’s capital gains tax rise on the housing market, some second home owners and buy-to-let landlords may decide to sell before the higher rate is introduced.  This could alter the supply/demand balance to move in favour of buyers and ease the current upward pressure on house prices.  If the new rates are effective immediately after Budget day on 22nd of June, then potential sellers will not have time to react and this will be one factor that doesn’t then affect housing supply.

Another reason why house prices have stayed high may be that real long-term interest rates – measured by index-linked gilt yields – have been low.  A low index-linked yield means that investors expect real short-term interest rates to be low in the future, which means people can afford to take on higher mortgage debt.  Or a low long-term real interest rate means the net present value of future rents is high, which should mean house prices are high.

‘No real answers then’, I hear you cry.  To be honest, no.  But I don’t think this rise in house prices is likely to bring about a repeat of the early 2000s boom as this would need index-linked yields to fall sharply.  As they are already under 1%, this is not going to happen – thus eliminating one factor behind a house price boom.  However, I do believe house prices have now ‘bottomed out’, except for a short-term blip relative to the new CFT implications.  Buy-to-let might now be worth looking into.

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Child trust funds scrapped

New chancellor George Osborne has advised that Child Trust Funds will be scrapped in January.  What does that mean to people who already have an account and those who are expecting a baby?

Child Trust Funds (CTFs) were intended to give children a financial head start in life.  Currently, every baby born after 31st August 2002 receives at least £250, with children getting a top-up payment from the government (usually £250) when they turn seven (both in voucher form).

In the future, government contributions into CTFs will firstly reduce and then stop altogether.  Subject to legislation being approved by parliament, the new government intends to reduce the amount of money that children receive at birth from £250 to just £50 from 1st August 2010.  Children from lower income households will receive £100, down from £500.  On the same date, it is planned that all government top-up payments at age seven will end.  This will affect all children that turn seven after 1st August.  From January 1st 2011, new vouchers will no longer be issued.

For those with CTFs already it is expected that they will continue to operate as they do now.  That is to say, they will likely continue to be CTF accounts until the child’s 18th birthday and will carry on benefiting from tax-free investment growth.  However, once the new legislation is in place, there will be no further entitlement to government contributions.

If you are expecting a child and it is born before the legislation to stop issuing CTF vouchers is in place and you meet the other eligibility requirements you will still receive a CTF voucher.  Alternatively, if you have received a voucher, but have not yet used it, you can still do so up to the expiry date shown on the voucher.  If you do not use it, HM Revenue & Customs will open an account for your child and tell you about it.

So, the good news is, for those who already have a CTF, they won’t lose anything – family and friends will still be able to top up existing accounts – up to £1,200 a year, and the account should remain in place until the child turns 18.  Such children can continue to benefit from tax-free investment growth.

For those who haven’t yet opened an account, but are entitled to one and have their voucher, please make use it while you can; as much as you can.  You may no longer receive a top-up when your child turns seven, but at least the account will be there and if you can, you will be able to top it up.

One final piece of ‘good news’ in all of this, the government will save £320 million from reducing and then stopping its contributions to CTFs.  It is part of a planned £6.24 billion worth of spending cuts this year.

If you want to know more about investments for your child, please call us on 01582 832253 or Email us.

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How about a tax free party?

So if Chelsea do the double (come on you Blues), or heaven forbid England do well in the World Cup, can you throw a tax free party for your employees?

Well, the good news is yes you can, as long as the total spend is under £150 per member of staff. This can cover the cost of the food, drink and also the costs of transport and accommodation.

Your team will no doubt cheer the fact they can also bring along their spouse or partner and there is no income tax or national insurance to pay.

This tax allowance lasts for the full financial year so you can throw both a summer and Christmas party and provided you stick to the less than £150 per member of staff figure, both parties will be tax free for the employees.

Watch out you don’t score an own goal however. If you spend over the limit the whole amount spent on the party will be liable for income tax and national insurance for both employers and employees.

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How good is your disaster recovery plan?

Most people understand the need for backing up their computers on a daily basis and even making sure another copy is kept off site to make sure data is kept safe in the event of computer breakdown, flood or fire. Most sensible business owners have contingency plans in place to cover many eventualities with regard to running their business properly. Nearly everyone has home and contents insurance. 

So why do people pay such little attention to the potentially biggest disasters – the death, disability or serious illness of the main breadwinners?

Like all good disaster recovery plans you should look at all the possibilities and the potential implications on your family or business.

Ask questions both personally (both spouses) and with regard to your business (all key people) if your are a business owner:

  • What are the financial implications of the death of this person?
  • What are the financial implications of the disability of this person?
  • What are the financial implications of the long term serious illness of this person?

Many people wrongly cover different people for the same level of insurance when the implications of the above are rarely the same. Joint plans are generally bad advice except for inheritance tax planning. Even covering your outstanding mortgage is unlikely to be correct as the financial implications are much wider and so the solution is more complex.

A mixture of term insurance (life and critical illness), whole of life assurance, income protection plans, accident sickness or unemployment plans, private medical insurance together with the correct types of trusts will usually supply the most suitable solution.

Good levels of insurance are the foundation of a solid financial plan which should be regularly reviewed by an experienced financial planner. The premiums are unlikely to cause you serious hardship but lack of suitable cover will almost certainly do so. Don’t let a disaster overtake you – plan for it today.

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Tax avoidance by gifting money to your children?

As the inheritance tax (IHT) nil rate band is now frozen for at least 4 years it seems that people are considering gifting money to their children to avoid this tax and also help their children onto the property ladder. 

These days credit is no longer easy to come by and lenders require large deposits and have much tighter lending criteria. Many first time buyers find it impossible to make that first step without help from Mum and Dad. However many Mums and Dads find themselves in the position where they are likely to pay large amounts of IHT and so passing it on to the children now rather than later seems a sensible approach.

However we urge you to carefully consider the following before giving the money away: 

  • Are you certain your assets continue to provide you with the income stream you require into your old age especially if inflation gets a grip in the later years? 
  • What happens if the children get married and then divorced (52% of marriages now end this way) – will half your gift walk away? 
  • What happens if your children get into a risky venture or are just spendthrifts and become bankrupt? 

When dealing with this issue financial planning is essential, as you need to consider your actual expenditure over at least a 5 year period. This takes into account the costs of replacing cars, washing machines, house refurbishments and even the odd more expensive holiday. Projections on different levels of inflation and performance on your investments should also be taken into account as well as the size of your emergency fund if it all goes wrong. 

Planning that should be looked into is the use of trusts to retain control of the money gifted by setting up loans to your children from a lifetime trust and also pre and post nuptial agreements. Providing these are set up, gifts may well be a sensible part of your long term strategy for helping your children.

We even have some clients who insist that some of the payments from their trusts to their children are used to fund their own annual financial planning meetings.  The purpose being to ensure the children are making best use of their money as part of a sensible financial plan.

A sound financial education may be the best gift you can leave your children. It’s not much good giving them the money if they don’t keep it.

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How long will your Trust last?

The legal system in the UK states that property cannot be held in a Trust indefinitely. Future interest in a property held in trust must take effect within what is called the perpetuity period. In practice most trusts are set up for a fixed period of 80 years. 

However the perpetuities and Accumulations act 2009 which comes into force on 6th April 2010 will make several key changes to all future will and life time trusts.

The key change is that a perpetuity period will no longer have to be specified as the new period of 125 years will apply to all lifetime trusts set up after the 6th April 2010. 

In addition accumulations (growth inside a trust) can now be made throughout the entire perpetuity period of the trust. This used to be the lifetime of the settlor plus 21 years. The previous limit of 21 years still applies to charitable trusts. 

The new law provides an opportunity to revisit existing trusts or existing wills that create trusts of significant value to extend the perpetuity period to 100 years if for some reason 80 years is deemed insufficient. However this extension can only be applied to lifetime trusts if the trustees “believe it is difficult or not reasonably practical for them to ascertain whether the lives of the beneficiaries have ended.

As always with any trust work experienced financial and legal advice should be taken before carrying out your wishes.

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Inflation and Bank interest rates

The Office for National Statistics has just reported that the consumer price index fell from 3.5% in January to 3% in February. This adds weight to the Bank of England’s view that price pressures will continue to fall this year as the recessions continues to drive a fall in demand and consumer spending. Further drivers were falls in gas prices and lower rises in food prices. 

The Bank’s most recent forecasts suggest that inflation may fall to less than 1% unless oil prices rise sharply or sterling falls again. This sounds like good news bearing in mind the low rates of return from all deposit accounts. However with inflation now heading back well towards its target the Bank is very likely to keep base rates at 0.5% until next year thus keeping interest rates down. On the other hand, if you are in a tracker mortgage and your mortgage rates are at all time lows this may be a good time to start paying off capital. At some point the recent quantitative easing may well rebound causing inflation and thus interest rates to rise sharply. A lower mortgage at that time will help.

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Pre-nuptial and post-nuptial agreements

Yesterday I held a meeting with one of the law firms we have done a lot of business with over the last few years with regards to trusts, Inheritance tax and Estate planning. However this meeting was with one of their family law divorce lawyers and the main topic under discussion was pre-nuptial and post-nuptial agreements.

Many of our clients have set up trusts over the years to help ensure their children have the means to retain their inherited assets in the event of divorce or bankruptcy. Although this is very sensible planning for most people with estates valued in excess of £650,000 we have not until recently stared to discuss the possibility of a more belt and braces approach.

It seems to me quite difficult to discuss pre-nuptial and post-nuptial agreements with someone you are about to marry or are already married to. All too American for us Brits? However, if such an agreement as a condition of becoming a beneficiary of a trust or will is something your parents or the trustees of a will insist on – that’s an all together different thing – and you should pass the blame to someone else!

For Pre-nuptial agreements – there is currently a case going through the Supreme Court (formerly the court of appeal) for the UK which should set a precedent as to how these cases are handled in the future. In addition there is some statutory law also currently being brought into play (depending on the next goverment) which will also help.

For post-nuptial agreements – these are already fairly well established and are already taken into account by the divorce courts in the rare instance someone has put one into place.

It seems the best scenario is to have both these agreements in place and also trust planning to be as safe as possible.

The overall costs of these types of plans are relativly negligable compared to the potential benefits and should be considered by most well off people for their children or themselves. As financial planners we are now including these arrangements in financial planning discussions with our  clients and can arrange meetings with the recommended law firm if required.

I will try and update you all on this as and when the ruling in the Supreme Court takes place.

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