Jennifer Adams warns of possible ways in which principal private residence relief claims might sometimes be incorrect.
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For most individuals selling their main home, the expectation is that any capital gains will be largely or fully tax-exempt because of principal private residence (PPR) relief.
However, tax cases have demonstrated the potential for costly mistakes, with incorrect claims leading to substantial capital gains tax (CGT) bills.
To qualify for a PPR relief claim, two conditions need to be fulfilled:
1. The property must not have been purchased solely for the purpose of making a profit.
2. It must be the individual's only or main residence throughout the period of ownership.
Periods of absence from the property may be permitted, depending on the circumstances.
Making a (trade) profit?
A common strategy for tax-free property portfolio sales is to nominate each property as a PPR in turn, prior to the sale. However, whilst HMRC may initially accept PPR relief claims for the first couple of sales, their ‘Connect’ system may flag these transactions when checking Land Registry records. This could lead to a challenge of the PPR relief claims on the basis that the reason for nominating the properties was to avoid paying tax, which may indicate a trading activity.
HMRC may also pursue taxpayers who frequently buy and sell properties within a relatively short period, arguing that those engaged in such activities are operating as a business and are therefore liable for tax and National Insurance contributions. Similar observations apply to property developers who purchase properties for development, move in after completion, and then resell them shortly afterwards for a profit.
What is ‘permanence’?
Although many tax cases have affirmed the need for a degree of permanence or continuity in residence, the quality of occupation and the expectations regarding residency are more critical factors than the length of time spent living there. Generally, a property should serve as the permanent residence for at least 12 months to strengthen a PPR relief claim, although claims have been successful for shorter periods in some cases.
Evidence is key – there needs to be “some evidence of permanence, some degree of continuity or expectation of continuity” for the claim to be valid even if, in the end, the claimant does not live in the property for as long as originally intended. HMRC will apply this standard at the outset of any HMRC enquiry challenging a PPR relief claim.
It is a matter of fact whether a property is the individual’s PPR or not, but to demonstrate the fact, suggestions include ensuring that utility bills are in the owner's name at the property address. Other documentary evidence could include receipts for home insurance, telephone bills and DVLA records showing the address as the main residence during the PPR relief claim period. Information considered in evidence by HMRC in the past has included fuel bills indicating that a property was unoccupied for part of a winter when the taxpayer claimed it was being used as their PPR.
Excessive PPR relief claims may arise if the property is not occupied as the individual’s main or only residence throughout their ownership period. While there is no minimum occupancy requirement for a PPR relief claim, many fail because the property needs to be occupied both before and after any period of absence (unless the absence is due to work away from home, in which case returning is not required). If the reason for the absence is work abroad, then any period of absence, no matter how long, is allowable.
Absences can be cumulative so long as one or more of certain conditions apply:
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Absences of up to three years (or two or more periods of absence which together do not exceed three years) may be treated as a period of residence.
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Absences of up to four years can be allowed if the distance from the place of work prevents residence at home or the employer requires the taxpayer to work away from home.
Unfortunately, it is often the case that for unavoidable reasons, the individual is unable to move back into the property after an absence. In such cases, even if the previous conditions have been met, the absence will not count, resulting in a potentially substantial portion of a gain being taxable. It does not matter whether the property remains empty or is rented during the absence.
Some relief is available, as the first year and the last nine months of ownership are always treated as periods of occupation, regardless of whether actual occupation occurs. This exemption can be valuable in situations where it takes a long time to sell the property and find alternative accommodation.
Getting 'flipping' right
An often overlooked tax relief opportunity is the ability to ‘flip’ ownership, which broadly allows PPR relief to be retained even when the owner is not residing in the property. The tax law permits the owner of more than one property to elect which is their main residence. The owner must have lived in the property at some point, but there is no specific duration for these purposes.
Having made the initial election, it can then be varied (flipped) as many times as required by giving a further notice to HMRC. There is no prescribed form or wording for the election, but the rules state that it must be made within two years of acquiring a second (or subsequent) residence unless there is a delay in occupation, in which case the date of moving into the residence is the trigger event.
If no election is made, HMRC will make its own determination on sale. Should the two-year time limit be missed altogether, there needs to be a ‘trigger’ event which will change what is termed the ‘combination of residences’ and reset the election date.
Examples of ‘events’ include:
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getting married;
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renting out one of the properties for a short period; when that let period ends, the owner can take up residence as the ‘combination of residences’ will have changed; or
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selling half the house to a joint owner, such that the seller is no longer in full ownership but is still in residence.
Every owner of two or more properties should elect which residence is to be treated as their PPR. An election should ideally be made as soon as possible following the purchase of the second property. Then, having made the election, the situation can be reviewed at any time up to the two-year anniversary date, thereby keeping all options open. Having made an initial election, there is no statutory limit to the number of times that the address of the property declared on the election can be changed.
Impact of renting a room
Letting a room or rooms in a main residence can be beneficial from an income tax perspective under the rent-a-room relief rules. However, the letting can have CGT implications as letting part of the property removes that part of the property from the cover of PPR relief while it is so let. This may or may not be problematic, depending on whether lettings relief is available to shelter any gain attributable to the let period and, where the gain is not fully sheltered, whether the CGT annual exempt amount is sufficient to cover any chargeable gain remaining.
Lettings relief shelters any gain not covered by PPR relief, such that the gain is only chargeable to CGT to the extent that it exceeds the lower of:
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the amount of the gain sheltered by PPR relief; and
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£40,000.
Practical tip
Spouses and civil partners can take advantage of the no gain, no loss provisions and transfer the property into joint names before any property sale where this is beneficial (e.g., to benefit from a second CGT annual exempt amount).
