Private Residence Relief – When Relief May Be Restricted

Sarah Bradford explains some potential restrictions within the rules for capital gains tax principal private residence relief.

No capital gains tax liability arises where a person sells his or her home provided that the property has been his or only or main residence throughout the period of ownership, except for all or any part of the last 18 months of ownership. If this condition is not met, principal private residence (PPR) relief generally applies to that fraction of the gain that related to the period for which the property was the taxpayer’s only or main residence, including the last 18 months of ownership, divided by the length of ownership. 

However, relief may be restricted where part of the property is used for the purposes of a trade, profession or vocation, or where there is a change in the part that is occupied as the individual’s residence, or where the property was acquired wholly or partly for the purposes of realising a gain from its disposal. 

By virtue of TCGA 1992, s 224(1), where a gain arises on all or part of a dwelling house, part of which is used exclusively for the purposes of a trade or business, or a profession or vocation, the gain must be apportioned between the part used as a main residence and the part used for the trade, business, profession or vocation. PPR is not available in respect of the portion of the gain that relates to the part of the dwelling house used exclusively for the purposes of the trade, profession or vocation.

It should be noted that the exclusion from PPR relief applies only to any part of the property which is used exclusively for the purposes of the trade, business, profession or vocation. Consequently, relief is not lost in relation to a room that is used for both business and private purposes. In their Capital Gains manual, HMRC cite the example of the kitchen in a small guest house which is used equally to provide meals for the guests and also to provide meals for the resident owner. As the kitchen is not used exclusively for the purposes of the trade, there is no restriction in the availability of PPR.

In a case where a part of the property is used exclusively for the purposes of a trade, business, profession or vocation, the gain must be apportioned between the residential and non-residential parts. The legislation does not provide how the apportionment must be made, and this must be determined by reference to the facts of the particular case. 

Some guidance as to HMRC’s approach to the apportionment calculation can be found in their Capital Gains manual. Their willingness to accept a simple apportionment based, for example, on the number of rooms used for each purposes, will depend on the tax at stake. HMRC note in their Capital Gains Tax manual (at CG64670) that in a mixed property, such as a pub with residential accommodation above, the business part would be expected to be of greater value than the residential value. Consequently, an apportionment based solely on the number of rooms or the floor area attributable to residential and non-residential use could produce an excessive amount of relief. HMRC advise their inspectors to seek a valuation from the Valuation Office Agency if an apportionment appears to be unduly weighted in favour of the residential accommodation. However, they also state that in small cases any reasonable apportionment will be accepted. 

It should also be noted that HMRC do not accept computations based on taking the value of the residential accommodation in isolation and deducting it from the consideration to determine the proportion attracting relief, as this is likely to produce excessive relief. 

Holly runs a small guest house, in which she also lives as her main residence. The property comprises twelve rooms, of which four are used exclusively for the purposes of her business. In July 2016, she sells the property for £900,000. She originally purchased the property in 1990 for £300,000. On sale she realises a gain of £600,000.

On a simple apportionment by reference to the number of rooms, two-thirds (i.e. 8/12) of the gain would qualify for PPR relief, leaving one-third (£200,000) chargeable to capital gains tax. However, HMRC contend that a greater value attaches to the non-residential part and eventually it is agreed that the gain attributable to the part used for the business is £250,000. PPR is available in relation to the remaining gain of £350,000.

Relief is only restricted where part of the property is used exclusively for business purposes. Where a small business is run from a room in the home, ensuring that the room is also used for private purposes will preserve relief. For example, a room used as an office in the day could be used in the evenings for the children to do their homework. However, there must be some actual private use – simply leaving private possessions in the room will not be sufficient.

A residence may be altered or extended over time and its use may change frequently. Provision is made (in TCGA 1992, s 224(2)) to ensure that where the use of the property changes, the amount of the gain qualifying for PPR is adjusted in a manner which is `just and reasonable’.

The provisions are wide ranging in their application; they bite where there is a change in what is occupied as a person’s residence as a result of the reconstruction or conversion of a building or for another reason, and there is a change in the part that is used for a trade, business, profession or vocation or for any other purposes. The adjustment to the relief will again depend on the facts in each case. However, the adjustment should reflect the extent to which, and the length of time over which, each part of the dwelling house has been used as its owner’s only or main residence. Relief is allowed for the final 18 months of ownership for any part which at some time has been the owner’s only or main residence.

It should be noted that this adjustment is only needed for periods where there is some residential use, but there are changes to the parts used for residential and non-residential purposes. If a property is used entirely as a main residence and is then used entirely for business purposes, relief is determined on a time-apportioned basis, with PPR relief being given for the period for which the property was the main residence or fell within the last 18 months of ownership.

The final restriction imposed by TCGA 1992, s 224 is in relation to development gains. The aim of PPR relief is to enable a home owner to buy a property of a similar standard in a rising market. The relief is not intended to exempt speculative development gains from tax. 

Relief is restricted (by s 224(3)) in circumstances in which a house is acquired wholly or partly for the purposes of realising a gain from disposal, or where there is subsequent expenditure on a property with a view to enhancing the property in order to make a gain. In the first case, no PPR relief is available. In the second case, no relief is given to the extent that the gain made relates to the enhancement expenditure incurred solely for the purposes of making such a gain. 

It should be noted that the restriction is not imposed where a householder buys (say) a home in an up and coming area in the hope that it will increase in value. The legislation is intended to apply where a property is bought specifically to make a gain, for example where someone buys a rundown property, does it up in six months and sells it at a profit. In a situation such as this it is also necessary to consider whether the individual is trading. A person who is in business as a property developer will be trading and their profits on sale will be subject to income tax rather than the gain being charged to capital gains tax.

PPR is a valuable relief, but it only applies where the property is used as a sole or main residence. Where this is not the case, relief may be restricted.