Jennifer Adams warns that capital gains tax principal private residence relief could be forfeited should a main residence undergo refurbishment.
Principal private residence (PPR) relief is one of the more valuable reliefs against a charge to capital gains tax (CGT) on the sale of a residential property. The relief is available on an individual's residence provided the house was occupied as their main residence throughout the period of ownership; the last nine months are also covered in the PPR claim. Furthermore, there are various provisions to cater for situations such as periods of absence.
Many taxpayers believe that if they have lived in the house as their main residence at any time, the entire period of residence and the last nine months are CGT-free. Whilst this may be true in most situations, there are conditions to the relief, one of which is that the property must not have been purchased ‘wholly or partly’ with the intention of making a profit (TCGA 1992, s 224(3)). Similarly, PPR relief is restricted if, after acquisition, expenditure is incurred 'wholly or partly' to make a gain on the sale. Therefore, any development and building profit arising from converting or reconstructing a PPR may be fully chargeable to CGT on sale; or it could be charged to income tax if the process is undertaken on a recurring basis.
'Converting’ or ‘reconstructing'
'Converting' or 'reconstructing' a residence generally refers to substantial structural work being undertaken to significantly alter a property's character, layout, or structure of a property which goes beyond repairs and maintenance. Reconstruction typically involves replacing major elements or completely redesigning parts of a building. However, TCGA 1992, s 224(2) is written widely such that it could encompass improvements. 'Improvements' to a residence will cover alterations, enhancements, or additions to a property that increases its value, are permanent and are not merely repairs or maintenance. Improvements typically extend the property's life, usefulness, or market value. They can include new features not previously present (e.g., adding a new bathroom or garage or possibly upgrading from single-glazed to double-glazed windows). Such alterations can be distinguished from regular repairs, which simply restore a property to its original condition without adding value.
Expenses on genuine improvements can be added to the acquisition cost of the property when calculating capital gains on sale. Routine maintenance or repairs (e.g., repainting, fixing a broken window) are not considered improvements and therefore cannot be included in CGT relief calculations (although should the property have been rented out at any time, such expenditure could be deducted from the income received). There may be instances where the property is only being improved to sell or upgrade. In this case, proof will be required confirming that profit was not the main reason for undertaking the works, but that the property's value increased during the improvement period.
Examples of refusal of PPR
HMRC has successfully argued that refurbishment activities indicated either a lack of genuine residence or that the property was intended for investment rather than as a main home. Increasingly, HMRC has won cases where the main reason for refusal was that the properties were uninhabitable before and during the refurbishments. A property must be liveable as a main home; therefore, should renovations make the property uninhabitable, HMRC may argue that the occupation was not genuine with the focus on 'quality' rather than length of occupation.
The case Gibson v HMRC [2013] UKFTT 636 (TC) underlines the importance of 'quality' of occupation. In that case, the taxpayer claimed his original intention had been to extend the property for a family home, but owing to the cost of alterations, he had instead ended up demolishing and rebuilding. However, he subsequently had to sell the property, again for financial reasons. Prior to the sale he stayed in the property for four or five months, using very basic furniture. The First-tier Tribunal (FTT) found that the ‘quality’ of occupation was insufficient to make the property his sole or main residence and denied the relief. Again, the FTT looked at the degree of 'permanence' or expectation of 'continuity' of occupation and found there to be none.
Proving it’s a PPR
To prove to HMRC that the property could not be lived in during renovations without losing PPR relief, it needs to be demonstrated there was a genuine intent to occupy the property as the main residence before and after the renovations, as well as showing why living there was not possible during the works. Keeping receipts and invoices from contractors for major work, especially for essential installations such as heating, plumbing, and electrics, shows that making the property habitable was the intention and priority. Registering the property as the official correspondence address for council tax and voting, even moving essential belongings into the property, can help to demonstrate commitment to the property as intending to be the main residence.
The case of Alison Clarke v HMRC [2014] UKFTT 949 (TC) shows how far HMRC will go to obtain confirmation that its refusal of PPR is valid. In that case, evidence from the local council confirming dates of occupation showed that the property was unoccupied for a long period. Gas bills indicated low consumption, the car had not been registered at the address for which PPR was being claimed, and the property was uninsured during the relevant periods.
How long to wait before selling?
Timing may be crucial if you have purchased a property requiring refurbishment and intend to make a PPR claim.
Ideally, the property must be fit to live in on purchase and you must actually reside in the property before, during and after undertaking the building works. On finishing the works, the longer the gap before selling the better.
Income tax implications
In some circumstances, the sale of a main residence property could be subject to income tax, rather than having CGT implications. Here we are looking at HMRC's definition of a business as 'an adventure in the nature of trade' (see HMRC’s Business Income Manual at BIM2006). HMRC invariably relies on this phrase to determine whether a transaction or series of transactions is taxable as trading income, even if the individual is not engaged in a trade in the usual sense.
For example, a property purchase or sale might be classified under this heading if there is evidence that the intention was to make a profit in a manner similar to trading. A high frequency of similar transactions, such as buying and selling multiple properties in a short period, can indicate trading. Should an individual have a history of similar transactions (e.g., buying a property, living in it for a period, renovating, living and then selling), HMRC would probably treat the property purchase as stock from the time it was clear that a 'trade' was being undertaken, and charge to income tax.
Builders, in particular, need to be careful when claiming PPR relief due to the specific nature of their activities as they often buy, renovate, and sell properties, which may lead HMRC to view all property transactions as 'adventures in the nature of trade'.
Is being taxed under income tax so bad?
Should HMRC rule that a trade has taken place, this is not always a problem as some costs will be deductible from profit (e.g., finance costs should the renovations be undertaken using a bank loan).
In contrast, claiming financing costs to fund improvements, etc., as a CGT transaction deduction is not permitted.
Practical tip
Consistent evidence showing commitment to the property as the future home is crucial. Evidence of intent increases the likelihood of HMRC accepting that any temporary uninhabitable state during renovations was necessary and outside your control, allowing PPR relief to be retained.
