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Legal Process & Taxes

The process of buying or selling a house is much more complex than that of buying or selling, say, a car. There are a number of reasons for this, apart from the obvious one that, for most people, a house costs a great deal more money than a car.

First, land is one of the few natural resources that is genuinely limited. We can make produce more cars, but the Earth has a finite dry surface area, and everybody wants a piece of it. This means that, as a form of property which can be owned, land is subject to different kinds of controls than other forms of property.

It is normal the vendor's lawyers that draft the main contract for the sale. In practice, most lawyers will use the standard-form contract provided for this purpose by the Law Society, and just amend it where necessary. The contract should, in nearly all cases, list in some detail what is, or is not, included in the sale. The statutory position is that, if the contract is silent on the matter, the sale includes the land, buildings, fixtures and fittings.. The vendor's solicitor will usually send his or her client a long list of things that are often found about the house, and ask the vendor to tick whichever are to be included in the sale. This list then forms part of the final contract.
If you are buying a leasehold property, the contract will probably be much more complex than in a freehold. This is because it will set out in detail the obligations that will arise between the landlord and the tenant -- who is responsible for repairs and maintenance; whether there is an ongoing rent commitment or service charge and how it is to be reviewed; what limitations there are in how the property can be used; whether you have to get the approval of the landlord before you can sell the lease to someone else; and so on.

Investigation of title

It is the buyer's responsibility to satisfy himself that the vendor really has the right to sell the house, and that no-one else has interests in the land that will disturb the new purchaser's ownership. The buyer must also be satisfied that the property represents good value for money, and is not falling down.

The process of investigation of title is largely the same for both freehold and leasehold properties, with the complication that the buyer of a leasehold has to investigate the landlord's title as well, as far as he is able.

As well as investigating whether the seller has good title to sell, you'll also want to investigate any encumbrances on the title. These are rights of third parties to interfere with your use of the land you are buying. In domestic conveyancing there are generally two kinds of encumbrance you will encounter: easements and restrictive covenants. These days, encumbrances should always be obvious from an inspection of the Land Register, but some will be enforceable even if they aren't obvious.
An easement is a right that someone else has over your land. The easements encountered most commonly are easements of access and easements of light. An easement of access is a right someone else has to enter your land for some purpose -- perhaps for a neighbour to cross your back garden to get to his own. An easement of light is a right for a neighbour to prevent you obstructing light entering his property. Easements don't come out of nowhere -- they will usually have been granted to your neighbours by some previous owner of the land, perhaps centuries ago. Once granted, easements stick like glue to the land, and can be difficult to remove. What makes it worse is that certain easements can be enforced against the landowner even if he was not aware of them when he purchased the land.

A restrictive covenant is an obligation to refrain from doing certain things on the land. In a housing estate, for example, you will almost certainly be prohibited from running a business from your house. This prohibition probably can be enforced by your neighbours, although they may not know this. You may be prohibited from building a fence more than a particular height, or keeping animals, or all sort of other things.

As well as investigating whether other private individuals might have rights against the land you are thinking of buying, it is generally necessary to consider also whether the local authority might want to interfere with the land. In particular, you will want to know if your land is subject to a compulsory purchase order, or is on the route of a proposed new motorway. Local authorities have standard forms which must be completed to make such enquiries. Waiting for responses to these forms is, for many people, the slowest part of the pre-contract stage of conveyancing -- it can take up to six weeks. There are a number of private search agencies that undertake to carry out the same kinds of enquiries in a much shorter time. Whether it is possible to employ such an agency depends to a large extent on whether it will satisfy your mortgage lender.

Surveys and valuations

Both you and your lender want to ensure that the property you are buying is good value for money, although your motives are different. The lender will insist on a valuation of the property, and will have a minimum standard to which this valuation must be conducted. Normally the lender will insist on instructing a valuer of its choice, and passing the cost on to you. It's up to you whether you want to instruct your own valuation as well as that of the lender. It is usually cheaper to pay the lender's valuer to do a more extensive survey than it is to instruct a completely independent survey. It is important to understand that the lender's basic valuation is only concerned with whether the lender will be able to recover its investment if it sells the property.

Exchange of contracts

Once you've established that the property represents good value for money, and you've got an agreement from a lender to advance the required funds, and you've established that the seller has good title to sell, and that the local authority is not planning to build a motorway in the garden, then it's time to make the commitment to purchase, and sign the contract. In the contract you will typically agree to advance a deposit, which is usually 10% of the purchase price. You will also agree (if the seller's lawyers have done their job properly) that the seller can keep all or part of the deposit if you aren't able to complete the transaction and pay the balance of the purchase price. Such an agreement amounts, in principle, to a penalty clause. It's a penalty clause because it is highly likely that the amount of money you would forfeit if you failed to complete the transaction is massively larger than the losses that would be incurred by the seller.

The contract will typically specify the date on which the transaction will be completed; on this day you will have to pay over the balance of the funds, and conventionally this is when you'll take occupation of your new house.
Once you have exchanged contracts, the house you are buying becomes your property `in equity'. This is a highly technical matter, but what it means in practice is that the courts would treat you as the owner if a dispute arose over the property, from the moment contracts are exchanged. This is in spite of the fact that you've only paid 10% of the money. The implication for you is that if the house were to catch fire after exchanging contracts, you could be compelled to pay over the balance of the money on the agreed date, for a pile of smouldering embers. So it will generally be your responsibility to arrange insurance over the property from the date of exchange, not the date you move in.

Priority search

Assuming that the land you are buying is registered, you will enter a priority search at the Land Registry shortly before completion of the transaction. This will reveal if the seller has done anything naughty with the property since you exchanged contracts (such as selling a lease of it to someone else), and will prevent any further dealing with the land for thirty days

Completion

On the appointed day, the seller will sign the deed of transfer, accept the balance of payment, and move out. If you are buying the property jointly with another person (your spouse, for example), the deed will state how ownership is to be divided between the new owners. Your choices, put simply, are `joint tenants' and `tenants in common'. Note that the word `tenant' in this context has nothing to do with the use of the word in the context of the landlord-tenant relationship. Tenant here simply means `owner'. As `joint tenants', the various owners have no individual share of the property; they all own all of it. As `tenants in common', each owns a particular share of the value. Suppose, for example, that a husband and wife buy a house between them. They could agree, for example, to be tenants in common of 50% of the value each, or they could be joint tenants of 100% of the value.

Stamp Duty Land Tax

You pay Stamp Duty Land Tax on property like houses, flats, other buildings and land.

If the purchase price is £125,000 or less (effective 23 March 2006), you don't pay any Stamp Duty Land Tax at all.

If it's more than £125,000, you pay between one and four per cent of the whole purchase price, on a sliding scale.

Residential Property Rate of

Purchase Price Stamp Duty

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£0-£125,000 0%

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£125,001-£250,000 1%

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£250,001-£500,000 3%

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£500,000 + 4%

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Property in disadvantaged areas

If you're buying a property an area designated by the government as 'disadvantaged', you don't pay any

Stamp Duty Land Tax if the purchase price is £150,000 or less.

Expenses and allowances on income from property

If you let out property you can deduct certain expenses and tax allowances from your rental income to work out your taxable profit (or loss). If you have several UK residential lettings you pool the income and expenses together. But you work out holiday letting and overseas letting profits separately.

Allowable expenses

The expenses you can deduct from letting income (unless it’s under the Rent a Room scheme) include:

letting agent’s fees
legal fees for lets of a year or less, or for renewing a lease for less than 50 years
accountant’s fees
buildings and contents insurance
interest on property loans
maintenance and repairs (but not improvements)
utility bills (like gas, water, electricity)
rent, ground rent, service charges
Council Tax
services you pay for, like cleaning or gardening
other direct costs of letting the property, like phone calls, stationery, advertising

If your annual income from the letting is less than £15,000 (before you’ve taken off expenses) you include the total expenses on your tax return; if it’s £15,000 or over you need to provide a breakdown.

Bear in mind that you can only claim expenses that are solely for running your property letting business. If the expense is only partly for running your business (or if you use the property yourself) then you may only be able to claim part of it.

Non-allowable expenses

When you work out your profit, you can’t deduct:

‘capital’ costs, like furniture or the property itself
personal expenses – costs that aren’t to do with your letting business
any loss you make when you sell the property

But you may be able to claim some allowances instead.

Allowances that can reduce your taxable profit

There are different types of allowance you may be able to claim for your capital costs. Capital costs include expenditure you make on assets like furniture and machinery. The allowances you can claim for some of your capital costs vary according to the type of letting.

UK and overseas furnished residential lettings

For furniture and equipment provided with a furnished residential letting (excluding UK furnished holiday lettings) you can claim a 'wear and tear' allowance. The allowance is 10 per cent of the 'net rent' - this being the rent received less any costs you pay that a tenant would usually pay.

As an alternative to the wear and tear allowance, you can claim a 'renewals' allowance. This covers the cost of replacing furniture or equipment, including small items like cutlery. To work it out, take the cost of the replacement item and deduct from it:

the amount you sold the old one for (if you got anything for it)
anything extra you paid for a better one

Once you've chosen which of these allowances to claim for a property, you can't switch between them from year to year.

UK Furnished holiday lettings

For this type of letting you can claim a 'capital allowance' for the cost of each item of furniture and equipment you provide with the property. Or you can claim a renewals allowance (explained above). You can't claim wear and tear allowances.

Once you make a choice for each item, you must keep to it.

To find out how capital allowances work see the section below: 'How much capital allowance can you claim?'

All letting properties

Whatever the type of letting, you can claim a capital allowance on the cost of things that you need for running your property letting business, like cleaning and gardening equipment. You can also claim for equipment that isn't for the use of a single let property, like a boiler that heats more than one property.

How much capital allowance can you claim?

The allowance depends on what you buy. You can usually claim 50 per cent of the cost when you buy it - but sometimes 100 per cent for some environmentally friendly expenditure. Each year after that you can claim 25 per cent of what's left. HM Revenue & Customs (HMRC) changes the percentages change from time to time. The allowance is deducted along with other expenses in calculating your profits

You'll get smaller allowances if you use the item privately or for anything other than your business.

Which year do expenses belong to?

You have to allocate expenses to the year they apply to – it doesn’t matter when you actually pay them. Sometimes you may have to allocate part of an expense to one year and part to another.

Losses

Normally, if your letting business makes a loss, you can carry it forward to a later year and offset it against your future profits from the same business. If it’s a UK holiday letting business you can offset your loss against all of your other income, not just your property income.

If you let out all or part of a property (including your home), how you’re taxed on the rent depends on the type of letting. If you let property abroad, you may have to pay UK tax on the rental income if you’re resident in the UK for tax.

The 'Rent a Room' scheme

If you are letting furnished accommodation in your own home to a lodger and your total receipts (rent plus income from meals, laundry service, etc) are £4,250 or below (£2,125 if letting jointly), you can get this income tax-free under the ‘Rent a Room’ scheme.

You’ll have to pay tax on anything over £4,250. Or you can choose not to use the scheme if you’d prefer to pay tax under the rules for residential lettings.

Tax on residential lettings

Letting residential investment property is treated as running a business - even if you only let out one property. And if you let out more than one property in the UK, they'll all be treated as a single business.

Whether you let one or several properties, you're taxed on the overall 'net profit'. You work this out by:

· adding together all your rental income

· adding together all your allowable expenses

· taking the allowable expenses away from the income

Working out your net profit like this means that you can offset a loss from one property against the profit from others. Your net profit counts as part of your overall taxable income.

Letting all or part of your home

If you let your home while you live somewhere else, your profits from the rent are worked out and taxed in the same way as for residential investment lettings.

The same rules apply if you let part of your home outside the 'Rent a Room' scheme. If you let part of your home this way, you can include a percentage of household costs like gas and electricity when you work out your allowable expenses.

Tax on UK furnished holiday lettings

The tax rules for furnished holiday lettings in the UK are different from the rules for residential lettings. The rules let you:

reduce your profit by claiming ‘capital allowances’ for the cost of furniture and fixtures that you provide inside the property you let
offset any losses against your overall income – not just against your rental income
Also, when you sell the property you may be able to take advantage of extra reliefs that’ll bring down your Capital Gains Tax bill.
Tax on overseas property lettings

You’ll have to pay tax on income you get from overseas property lettings (whether you bring the money into the UK or not) if you are ‘resident, ordinarily resident and domiciled’ in the UK. If you are ‘resident’ but either ‘not ordinarily resident’ or ‘not domiciled’ in the UK you may only have to pay tax on any money you bring into the UK. For an explanation of these terms and to find out more read our main article.
If you’ve already paid foreign tax on your letting income, you can usually offset this against the UK tax you’ll have to pay on it.
Record keeping for landlords

If you let out property, you’ll have to keep records of your income and expenses for at least six years – whatever type of letting it is. HM Revenue & Customs can ask to see supporting information for your figures at any point during this time.

Even though you can’t claim expenses when you use the Rent a Room scheme, it may still be worth keeping proper records. You’ll need them if you decide to opt out of the scheme later.

Declaring and paying tax on your rental income

If your taxable income from rent is £15,000 or more in a tax year you must declare it on the full Self Assessment tax return. If it’s under £15,000 you may be able to complete a shorter four-page return. If it’s under £2,500 your Tax Office may be able to collect any tax you owe through PAYE (Pay As You Earn).

Tax on the sale of your main home

You do not have to pay tax as long as:

you bought it, and made any expenditure on it, primarily for use as your home rather than with a view to making a profit.

the property was your only home throughout the period you owned it (ignoring the last three years of ownership).

you did actually use it as your home all the time that you owned it and, throughout that period, you did not use it for any purpose other than as a home for yourself, your family and no more than one lodger.

the garden and area of grounds sold with it does not exceed 5,000 square metres (about one and a quarter acres) including the site of the house.

If you are married or in a civil partnership and not separated you and your spouse or civil partner can have only one such residence between you.

Even if all these conditions are not met, you may still be entitled to tax relief.

Tax on property that’s not your main home

You will normally have a chargeable gain if your property is worth more than you paid for it when you sell or dispose of it. However, the first £8,800 of your total taxable gains are tax free (tax year 2006-2007).

Second, land can be subject to multiple interests. What this means is that a number of different people can claim rights over the same patch of ground at the same time. If property is subject to a lease, for example, we have to consider the rights of the leaseholder, the rights of the freeholder, the rights of mortgage lenders, and perhaps the rights of other people in the neighbourhood. If a neighbour has a right to walk over your garden to get to his house, that right might be considered as a limited form of ownership of your land.

Because the nature of land ownership is complex, and buying land is filled with perils, various safeguards have been put in place over the years to prevent people being financially devastated. These safeguards can be frustrating and, to be fair, do account for a lot of the delay experienced in house purchases; but they are there to protect the parties to the transaction.

The first safeguard is that to transfer a `legal estate in land' (that is, a freehold or lease) the seller of the land must use a deed. A deed is more than just a contract; it is a contract accompanied by certain formalities. This reduces the likelihood that a person can sign the document carelessly, or under duress. In addition, the document must contain some words such as `this document is executed as a deed', to impress on the signatories the formality of the undertaking. So, for Vendor to transfer his property to Purchaser, the vendor must execute a deed: he must sign a document expressed to be a deed, and in the presence of at least one witness. In modern terminology the deed that completes the sale transaction is called a deed of transfer, or just a `transfer'.

The second safeguard in land transactions is that now most land sales must be registered with a governmental agency, the Land Registry. In short, it is now usually possible for a prospective purchaser to find out most of what he needs to know about a property from the central register, rather than by inspecting a pile of decaying and antiquated title deeds.

Freehold & Leasehold

There are two ways in which land can be `owned' -- freehold and leasehold. You have to be a bit careful about the use of the word `owned' in the context of land because, technically, only the Crown can own land. What the rest of us own is an `estate in land'.

In simple terms, freehold ownership is of unlimited duration, and the owner's rights are not circumscribed by anybody else's ownership of that land.

A lease is of a limited duration, and the owner of a lease will have rights in the property that are set out by an agreement between himself and the landlord. The landlord may own the freehold, but there is no reason why the landlord should not himself be a leaseholder of a different landlord. Since 2003, a lease of more than seven years is subject to essentially the same conveyancing mechanisms as a freehold, and must be registered with the Land Registry. Before 2003 this only applied to leases over 21 years.

Despite the similar conveyancing process, the sale of leasehold property is technically much more complex than that of freehold property. There are two reasons for this. First, the buyer will invariably have to assume obligations to his landlord, such as an obligation to maintain the building, and these obligations can be very extensive and technical. Second, the buyer of leasehold property needs to be concerned not only with the investigation of title (ownership) of the person from whom he is buying the lease, but also with the title of the landlord(s) involved. It is entirely possible that the vendor of the lease has a perfect right to sell the lease, but there is some defect in the landlord's ownership of his own interest.

The Process

Buyer makes whatever financial arrangements he needs to buy the property; if a loan is required, it will usually take the form of a mortgage.
Seller drafts a contract and sends it to the buyer
Buyer examines the contract and makes necessary changes. The contract may pass back and forth a number of times.
Buyer investigates sellers title, to ensure ownership and general condition of property.
Buyers mortgage company will conduct a valuation to assess the suitability as security.
When both parties are happy, they agree a date for completion of the transaction. This is written into the draft contracts, which are then exchanged. A deposit of 10% is usually paid buy the buyer at this point.
The buyer will then enter into an agreement with the lender to place a charge over the land in the lenders favour.
If the land in question is already registered at the Land Registry then buyer enters a priority search against sellers register entry, which prevents seller dealing with the land against buyers interests between exchange and completion
Buyers drafts a deed of transfer and sends it to seller
Seller examines the deed and suggests what changes he sees fit,it is rare for there to be significant changes.
On the appointed day, seller and buyer sign the deed of transfer, and hands over the keys to the property to buyer
Buyer then registers the transaction at the Land Registry; any mortgage lenders register their charges. Recent changes to the law now mean that a transaction cannot be registered without a certificate from the Inland Revenue confirming that an stamp duty has been paid. So the purchaser, or his legal advisor, will usually complete and SDLT1 form and send it to the Revenue shortly before or immediately after completion. The Revenue send back a confirmation certificate which has to go to the Land Registry with the other paperwork.

Drafting and negotiation of the contract

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