What would be our best tax position?

Question We have two flats in London, converted from a terraced house. We bought upstairs in July 1982, and lived there until July 2001 as our only residence. It was then renovated and let, but there have been long void periods. It was recently redecorated and is now let. In June 2011, we bought the downstairs flat for £425,000, already tenanted but who has recently left. The flats are worth about £700,000-£750,000 each. Downstairs needs complete renovation before it can be re-let. The decision we need to make is either: (a) to renovate and re-let now; (b) sell both flats separately in different years, or together to a developer; or (c) convert the flats back to a house and redevelop ourselves. Recent house sales in the area have been between £2-3 million. We would expect to do this in the next two or three years when we retire and the potential combined effect of capital gains tax and inheritance tax will play a large part in our decision. We are also not clear of the treatment of renovation or future conversion in the tax computation, but clearly inclusion would help mitigate the bill. What would be our best tax position?

Arthur Weller replies:
There is a relevant saying: 'Don't let the tax tail wag the commercial dog'. Do what is best for you commercially, and think about tax second. Whatever profit you make you are going to have to pay tax on it, that is unavoidable. You will get a certain amount of capital gains tax principal private residence relief on the upper flat. Obviously, renovation or refurbishment costs are an allowable expense to offset against any profit.