Making The Most Of Main Residence Relief

Alan Pink looks at some of the well-known and not so well-known ways of reducing capital gains tax on the sale of a property by using main residence relief.

Most people know that you don’t pay capital gains tax (CGT) in the UK when you sell your own home. But very few know how wide ranging, flexible, and even generous the relief can be in the case of properties which have not been, or have not always been, your main residence. 

So, I’ll start off by running through some of the ‘wrinkles’ and extra reliefs that there are, and conclude by showing just how much difference they can make to your tax on selling a property. 

1. Part use of business

A lot of people are concerned that, if they work from home and claim a proportion of the home expenses against tax, they could end up paying some CGT when they come to sell the house. 

In fact, most people’s fears in this area are misplaced. If any of the property is used exclusively for business use, then there would be an apportionment of the gain between the business part of the house and the private part of the house. This could be the case where, for example, you have a flat over a shop and the shop is never used for private living. This is a long way from the ‘kitchen table business’ scenario, though, where a person uses his home to do business from but has no part of the home which isn’t also used, at different times, for private purposes. Even where you have a fully fitted out ‘office’ in the home, you can avoid any CGT problems by using this office for non-business purposes, such as paying your own bills and looking after your own personal finances. 

2. Part occupation

Where, during your period of ownership, you have had a property as your main residence, but there has also been a period where it has not been your main residence, you still get an element of CGT exemption when you sell; corresponding to the proportion of the period of ownership in which it has been your main residence. 

3. The last 18-month rule

Where you have qualified for relief for any part of your period of ownership, no matter how short, you are also given the last 18 months’ ownership free! This means that, on the time-apportionment basis, the last 18 months will also be treated as part of your exempt portion of ownership. 

4. ‘Deemed’ (or ‘pretend’) main residence

If you have more than one residence – for example, a house in the country and a flat in town – only one of these can be your actual main residence. Your actual main residence is where the real base of your existence is, and it’s usually not difficult to decide which of your residences this is. However, where you have two properties that can be described as a ‘residence’ of yours at all, you can choose which one you want to be treated as your tax-exempt residence. This is done by way of a formal election letter sent to HMRC and, in the case of married couples, signed by each spouse. 

It’s important to be clear here what the election is saying. It isn’t saying that the elected property is your actual main residence. In fact, if anything it’s saying the precise opposite to this. It’s saying that, even though the nominated property isn’t, in reality, your main residence, you want it to be treated for tax purposes as if it were (if the property were your actual main residence, there would be no need to elect it in order to get the exemption). 

So, what you definitely don’t need to do is pretend that the facts are other than what they are. For example, you don’t need to send out change of address cards, ask for all bills to be sent to the nominated home, etc. All you need to be able to do, if it is ever questioned by HMRC in the future, is to show that it is one of your residences, even if it is only a second or third, etc., residence whose occupation is subordinate to your real main residence. 

5. Out of time to elect?

Not necessarily! The rules state that, if you are going to nominate a property as your exempt main residence as described above, you have two years to do it. The statutory provisions aren’t exactly crystal clear on what is meant by this, but HMRC interpretation is that you have two years from where there is a change in your total combination of residences to make an election to the effect that one of those residences is to be treated as your tax exempt main residence from the date of that change in circumstances. 

For example, if you have just one home but you buy a second home in town, or in an agreeable country location, you have two years from when you buy that second home (or when it becomes habitable as such, if this is later) to elect which of the two residences you now have should be treated as the main one. 

But this two-year window can be extended in ways which are perhaps somewhat unexpected. Let’s take the case of a person who has a house in the country and a flat in London, both of which are available for occupation, and both of which have been owned for many years. Because they’ve both been owned for many years, it’s no longer possible to elect the London flat as your main residence, and let’s say that, in this case, your house in the country is the real base of your living. The problem is that the property in London might have gone up in value much more than the house in the country, and you would prefer to have the exemption to cover that. It’s also more likely that you’re going to sell the London property. 

So how do you get to elect the London flat as your main residence, now that the two-year window has closed? 

The answer is, you acquire another property as a residence. Perhaps you are considering buying a small place in Spain to supplement your two other ‘homes’; or perhaps you are looking to replace the London flat with another residence. If you buy the Spanish villa or the replacement property before you sell the London flat, this has created a third residence, which enables you to elect not just ‘property C’ but even the London flat. Depending on the circumstances, achieving even a short period of deemed main residence for the London flat could make a significant difference to the total tax liability.

6. Lettings relief

Where, and only where, you have qualified for main residence relief for a proportion of your period of ownership, but for a different period the property is let to tenants, you can claim relief against the taxable proportion of the gain corresponding to the let period of up to £40,000, or the amount which is exempt under the other provisions, if this is less. This is a generous relief introduced many years ago to encourage people to let their properties and thereby relieve the housing shortage. 

Let’s take the case of a flat which is owned for ten years and realises a £100,000 gain, that is £10,000 per year. Let’s assume that the flat is a second home, and the owner never lives in it as his actual main residence. After two years, the owner buys a villa in Spain which he uses as an occasional residence, and again his main residence remains the same, and it is neither of these properties. At the end of the fourth year, tenants move into the flat.

The computation of the gain on sale, if no planning is done, is relatively simple. Making certain assumptions, the gain of £100,000 has deducted from it the annual exemption of about £11,000, leaving a taxable gain of £89,000. Assuming that the full 28% rate of tax applies to this, the tax is therefore about £25,000. 

However, taking advantage of some of the above reliefs, let’s assume that the owner takes advantage of the acquisition of the Spanish villa at the beginning of year three and elects for the flat we are looking at here to be his deemed main residence. 

The CGT computation is revolutionised by the submission of this election, as follows:

In these circumstances, then, we can see that the tax has been reduced to one-fifth of what it would have been because the deemed main residence election has opened the door to all the other reliefs.