Coming Soon: Private Residence Relief Restrictions

Lee Sharpe looks at forthcoming proposed changes to capital gains tax private residence relief for homeowners as announced in Budget 2018.

The vast majority of readers will know that selling one’s home is tax-free. The capital gains tax (CGT) legislation to give effect to this is commonly referred to as ‘principal private residence (PPR) relief’ and starts at TCGA 1992, s 222.

The government is proposing to restrict the relief; in Budget 2018, it was announced that access to what is referred to as ‘lettings relief’ and the ‘final period exemption’ were to be significantly curtailed for disposals from April 2020 onwards. This article looks at the proposed measures in a little more detail.

Readers should note that, at the time of writing, the measures are subject to consultation, and the rules as finally adopted may differ to the regime as set out below. 

The legislation currently states that, where a person is entitled to claim PPR relief on the disposal of his or her main residence, the final 18 months of ownership will be deemed to be qualifying for the relief, broadly without exception. This was reduced from 36 months, for disposals on or after 6 April 2014 (although the 36-month period was retained for those moving into care, and for those with a disability, and will be so again under the 2018 announcement). 

It was proposed in Budget 2018 that this be further reduced to just nine months for disposals from April 2020.

This relief does mean that both the ‘old’ home and a ‘new’ home may qualify for PPR relief simultaneously, but it is not a particularly generous overlap period. It is difficult to see what mischief might be remedied by reducing this so-called exemption to a quarter of what it was just five years ago!

HM Treasury nevertheless seems to reckon that nine months is quite generous, given that this is ‘still twice the length of an average property transaction’. 

Lettings relief allows a person to claim relief for periods where they have let out the property and, at the moment, the owner does not need to occupy the property in order to benefit from this relief. 

More precisely, so long as the property qualifies as the owner’s main residence at any time in his period of ownership, lettings relief may apply, and the owner does not need to be in occupation during the period of letting. 

This may sound quite appealing to the buy-to-let property investor, but there is an important catch to lettings relief; it cannot exceed the lowest of:

1. the gain attributable to the period during which it was let;

2. £40,000 per owner (so double if owned jointly by spouses/civil partners); or

3. the gain attributable to the period for which it qualified as the owner’s PPR.

It therefore follows that a landlord cannot benefit significantly from lettings relief unless it is genuinely and substantively his only or main home.

Samantha bought a house in 2007 for £100,000 and lived in it as her only home for 18 months. She then bought and lived in another house with her partner, letting out the first house until it was sold 12 years later in 2019, for £200,000 (i.e. a gain of £100,000).

Under the current rules, Samantha’s total period qualifying for PPR relief is:

First 18 months’ actual occupation as a residence in 2012 plus last 18 months’ deemed occupation as a residence up to sale in 2019 (final period exemption). This totals 36 months, or three years. One-quarter of the gain is eligible for PPR relief, i.e. £25,000.

The gain eligible for lettings relief is the lowest of:

This means that, despite lettings relief being ostensibly £40,000 per owner, in this example, Samantha will get only £25,000 lettings relief

Of course, if Samantha is relying on the ‘final period exemption’ as outlined above, then reducing it from 18 months to just nine months will also reduce her eligibility for lettings relief – a ‘double whammy’.

Despite the protection from abuse already contained in the legislation, the government has decided that from April 2020, the owner will have to stay in residence at the property if he or she wants to claim lettings relief.

Readers may be aware that the government seems to have a ‘hate/hate’ relationship with landlords, particularly those whom it sees as opportunistic, hence the interest relief restriction for borrowings for residential lettings, and it’s trying (and quietly failing) to restrict rent-a-room relief so that the landlord essentially had to remain physically present while letting out rooms (to be clear, the rent-a-room relief regime already requires the claimant to continue to treat the property as their home, so trying to tighten up the rules as they did earlier in 2018 suggests a fundamental misunderstanding of how the regime was supposed to work).

However, the Budget 2018 ‘Red Book’ reveals that HM Treasury hopes to gain almost £500 million from these restrictions by 2023/24.

One of the key problems with taxing long-term assets is that CGT ignores inflation. We used to have indexation allowance, which boosted the allowable base cost of assets and improvements by reference to the retail price index in an attempt to exclude inflation from the taxable gain. This was replaced in 1998 by taper relief (and it could be argued that non-business asset taper relief, such as might apply to most properties, had a similar effect). This was replaced by…nothing at all, since apparently such adjustments are too complex. 

It could reasonably be argued that a homeowner or a property investor who has seen his or her property’s value increase from, say, £70,000 in 2000 to £350,000 today has achieved nothing; if they want to buy a similar replacement property for a similar price elsewhere, they have made no gain at all because all such properties now cost £350,000 and the arithmetical gain is meaningless. 

Of course, different types of asset have experienced inflationary pressures to varying degrees. But this is advantageous to homeowners (or to property investors) only if they can ‘cash in’ their property for another type of asset that has not likewise grown in cost over the last 20 years. Homeowners eligible for PPR relief do not tend to cash in their homes (except for another house) until they die – and HMRC already has a tax for that.

The government intends to consult on these proposed measures before publishing legislation later this year. As with all such measures, the likelihood is that they will be implemented even if they are unreasonable, as the government eyes the potential tax yield. 

It seems likely that the final period exemption will apply as it stands, but lettings relief while not in occupation may remain eligible for letting periods up to April 2020 and be restricted to periods while the landlord also occupies the property only from April 2020 onwards. If so, there may not be an immediate ‘cliff-edge’ tax cost to the change, until non-qualifying lettings periods stretch beyond April 2020 to the point that, for example, the CGT annual exemption is exhausted. 

Landlords who hope to benefit from lettings relief, in particular going forward, will want to check with their advisers on the detail of the legislation and to get a sense of when the implicit gain might become unacceptably expensive. Advisers may also want to keep an eye on whether or not the changes might affect Statement of Practice 14/80, and/or HMRC’s position on Owen v Elliott [1990] STC 469.