Alan Pink looks at what is, arguably, the most favourable relief available against capital gains tax, and ways in which you can accidentally forfeit it.
This article addresses the situation of individuals who are resident in the UK; there are complex new rules relating to non-residents who seek to claim main residence relief against UK properties, but these are outside the scope of what we are looking at here.
Capital gains tax (CGT) main residence relief is familiar to most UK property owners, and even tends to be taken for granted. When you make a gain on selling a property which has been your only or main residence all the time you’ve owned it, that gain is tax-free. Not all countries have this relief, however, as Boris Johnson found (for example) when the US slapped an assessment on him for a gain made on selling a UK property, simply on the grounds that Mr Johnson, having been born in the US, counted as a US citizen.
The basic rule, as we’ve said, is perfectly simple. If you’ve lived in a property as your main residence throughout your period of ownership, the whole gain is exempt. But, of course, there are always complications in real life and in the tax system, and what this article seeks to do is set out some of the pitfalls – and, by implication, how you can avoid falling into them.
1. Trading in property
One of the things HMRC don’t want to do is enable people who are basically property dealers or property developers to realise tax-free profits. So there’s an exception to main residence relief, which applies where a property has been acquired with the aim of realising a gain from selling it.
In some ways, this is quite a puzzling exception. Anyone living in London or the home counties can’t fail to have in mind the idea of their home increasing in value when they buy it. So, is this anticipation of ‘profit’ going to land such homeowners in trouble with HMRC?
Generally speaking, I think the answer to this question is ‘no’. Whether consciously or not, HMRC seem to take the approach of not enforcing this rule at all harshly, or indeed not enforcing it at all except where they have their talons in a particular individual for some other reason. If readers’ experience is any different, please let me know.
There are actually two layers to this rule effectively, though. Firstly, there is the rule that applies where you are making a capital gain from selling a property, in which you have lived as your main residence. Secondly, there is a possible line of attack, which actually is more frequent, to the effect that the property is actually not a capital asset of yours at all, but is stock-in-trade of a property development business.
This brings income tax into the forum, and the important technical point to note is that there is no relief against income tax for main residences.
This brings us on to a practice which is common amongst certain individuals who are skilled in building and allied trades. Rather than simply acquiring a property, doing it up, and selling it, they become ‘serial occupiers’ of their subject properties as their homes. So an individual moves into property one, does it up whilst living in it and sells, then buys property two, to which he does the same, and so on and so on, up to properties nine, ten, eleven, twelve etc.
This is actually quite a dangerous approach, because HMRC are within their rights to test the situation and see whether this is actually a trade of property development. The word out on the streets is that you are OK doing this two or three times, but if you do it too many times, or too frequently, you could end up with a nasty shock in the form of income tax assessments (which can normally be made up to four years in arrears).
2. Establishing a property as a ‘residence’
This is an area of judgment of the facts, and can relate both to the quality and quantity of your occupation of a property as a residence. It’s best illustrated by referring to a real-life case, where an individual was refused main residence relief, and where the courts on appeal upheld HMRC’s refusal.
In this case, an individual occupied the property, or so he said, for a period of about six weeks. On investigation, it appeared to HMRC that the character of his residence was more in the nature of ‘camping out’ in the property than really moving in and living there as any kind of permanent home. The point is that the individual didn’t have any other home, and therefore you would have thought that main residence relief should be given, if only by default. However, he lost out in this case because he didn’t take the need to really ‘move in’ seriously enough.
3. Multiple residences
The rules are quite clear, also, about what happens when you have more than one home. In a sense they are clear, that is. In the absence of any specific claim or election being made, the dwelling which is your actual main residence, as a matter of fact, is the one which secures relief; you can’t have relief for more than one property, and this includes a married couple, who can only have one main residence between them.
Unjustly enough then, one way in which you can lose main residence relief on a property is by getting married! It’s quite common for couples who are actually cohabiting but who are not married to be able to establish that they each have a separate property, which is their main residence. This is either as a matter of fact or by way of a main residence election (of which more below). If they marry, however, the rule that a married couple can only have one residence kicks in, and therefore one of the properties will lose relief.
The point of the main residence election is that you can choose which of two or more properties is to be given the tax exemption. But you have a tight deadline, and you can only elect within a period of two years from the date on which it becomes necessary to decide which of two or more residences is to be treated as the main one.
Very often, I come across the situation of the couple who have a house in the country and a flat in town. The house in the country tends to be the ‘actual’ main residence, which is more the base of their existence than the flat in town, even if they do spend a lot of time in the flat. If they come to me having owned both properties for more than two years, the opportunity to put in the election has been lost – subject to what I will come on to say. And, unfortunately, in this sort of situation it’s often the flat in town which is showing the bigger gain of the two, and on which you would rather have the tax exemption.
It’s very important to note that a main residence exemption doesn’t involve any kind of pretence or ‘window dressing’. If you have a home and a second home, electing the second home as your main residence for tax purposes is not telling the taxman that this is your actual main residence as a question of fact. If anything, it’s saying the exact opposite; it’s saying that the second home is not your main residence, but it is a residence of yours and you want it to be treated as if it were the main one. So there’s no need to send out change of address cards, etc., etc., to make out that your second home is actually your main one.
And what if you’ve missed the two-year deadline? Well, you can actually set the clock back to zero if you acquire any other residences. To take an example, let’s say a couple has a house in the country and a flat in town. They also buy an apartment in a Spanish resort, which is intended for holiday use by them (even if it’s also let out at other times). The acquisition of this third property means that there is a question to decide again as to which of the properties owned by the same taxpayers is the main one. So paradoxically perhaps, the acquisition of the Spanish apartment could enable this couple to elect the London flat as their main residence from the date the Spanish apartment is acquired. Confusing?
4. Periods of absence
The main residence CGT rules are actually quite benign when looked at overall. One example of this benignity is that periods of absence, in some circumstances, are treated as if they were periods in which you were continuing to occupy the dwelling as your main residence – and so there needs to be no apportionment of the gain between exempt periods and non-exempt periods. These periods of absence which count are:
- any period of absence not exceeding three years;
- any period of absence, without limit, where the individual is working outside the UK; and
- any period of absence of up to four years in total because of the individual having to work elsewhere in the UK.
Generally speaking though, the requirement for these periods of absence to be counted as if they were exempt periods of residence is that you are living in the property as your residence both before and after the period of absence. It often seems to happen that, for avoidable reasons, the individual never moves back into the property. In these circumstances, even if the requirements of the above bullet points have been met, the period of absence will not count, and a possibly substantial proportion of the gain will be taxable.
This article was first printed in Property Tax Insider in October 2017.