Tax IssuesSelling a property with development potential exposes the vendor to be taxed on that very 'potential', writes Caroline Madden

As everyone knows, those two magic words "development potential" invariably spell big money when it comes to property sales these days.

But, what individuals hoping to cash in on the development potential of their house or garden may not realise, is that those magic words can also have costly tax implications.

In general, a person can dispose of their private home and grounds of up to an acre tax-free. Principal private residence (PPR) relief exempts gains on such transactions from capital gains tax (CGT), as long as certain conditions are met. However, this relief is restricted if the price paid for the property reflects an element of development potential.

Take, for example, a house in Ranelagh with a half-acre garden valued at €2 million, given that the garden is unlikely ever to receive planning permission. If this property is sold at the market value to a private buyer, and the vendor qualifies for PPR relief, then the vendor will not be liable to CGT on any gain arising from the sale.

If, on the other hand, it is possible that planning permission may be granted for the site in the future, and a builder - perhaps with plans to knock the existing property and build apartments - snaps it up for €4 million, then CGT will apply to the portion of the sales proceeds relating to the development potential. In other words, the €2 million premium which the builder is willing to pay, known as the "hope value" of the property, will be liable to CGT.

"Basically, the amount that is tax-free is the amount you would sell it for if it didn't have development potential," says Declan Butler, partner at Deloitte & Touche.

"In general terms, they pay tax at 20 per cent on the [ development land] gain."

And, considering the phenomenal gains currently being generated on development land sales, the tax on these transactions can be quite considerable.

There can be a degree of uncertainty when calculating the CGT arising on such sales, Butler says, as it can be difficult to determine exactly what proportion of the sales price relates to development potential. "The 'hope value' for getting planning [ permission] is what it comes down to - and that's not an exact science," he says.

An auctioneer or surveyor will generally be required to estimate the "current use value" of the property - that is, the value of the property if it was never going to be developed (€2 million in our example).

Individuals considering selling off their garden, or even part of it, to a developer, while retaining their house, should bear in mind that a decent slice of their profit may well be destined for the Revenue's coffers, as PPR relief does not apply in this scenario.

Despite the tax implications, this is becoming an increasingly popular option. "Certainly, there has been a trend towards it because of the premium that sites are making," says Paul Murgatroyd, economist with Douglas Newman Good. "As property prices have risen it's become more frequent and more common."

He adds that some property developers are now posting notes through doors of houses with large sites to the side, enquiring whether the owners are interested in selling their site.

Parents thinking about transferring a site to their child will be glad to know that the specific exemption relieving such transfers from tax is not affected by development land provisions.

In the past, development land rules would not have applied to apartment sales but, as property developers begin to buy up old apartment blocks ripe for redevelopment, owners selling up at a premium must also beware.

For example, if a person sells their apartment for €2 million to a developer and other units in the block have been fetching €500,000 until recently, then the development land provisions are likely to apply.

"People haven't really focused in on that," Butler says. "[ The developers] are paying a premium because they see development potential. The whole purpose of the section [ of tax legislation] is that you don't get principal private residence relief on the development potential. If someone comes in and tries to buy a whole block and pays people way over the odds, the amount way over the odds would not be tax-free."