Alan Pink looks at planning to reduce capital gains tax on selling a property by occupying it as a residence – and the hurdles that need to be overcome.
Most people know that in the straightforward situation where you sell your home, you don’t pay capital gains tax (CGT). But it’s not so well understood that main residence relief can make a huge difference to the CGT you pay in other, much less straightforward situations.
Case study – a flat in London
Let’s start with an example. Matt is very much a country mouse but has decided that buying a flat in London is likely to be a very good investment. Whilst he has no intention of upping sticks from Camberwick Green (where he lives) and moving up to the Smoke, he does think it would be nice to have a pied-à-terre somewhere in town, and to be able to let it out if and when he doesn’t use it himself as a second home.
So, he finds a suitable flat, buys it, and occupies it in a fairly desultory and occasional manner for the first twelve months or so. After that, he decides that his need for a London pad is nothing like as great as he thought, and indeed the hassle of changing sheets, etc., makes it easier to stay in a hotel on the few occasions he spends overnight in London.
He puts the property on the market and it is let from about the first anniversary of the date he purchased the property.
Roll on ten years, and Matt sells the flat, realising a capital gain of £200,000. Does he get any tax relief against this gain, or does he have to pay 28% tax (i.e. the applicable rate for him) on the whole lot, barring a small amount representing his CGT annual exemption?
The answer is that this depends on whether he knew what he was doing at the time or took appropriate advice. Let’s say he did and went to see an accountant who suggested that he put in a ‘main residence election’ to nominate the London flat as his main residence – even though his property in Camberwick Green was his real home in the deepest sense.
The effect of putting in this election, subject to the warnings I am going to give below, is really quite dramatic in terms of the tax he has to pay:
- for a start, he is treated as occupying the property as his main (and, therefore, CGT exempt) residence for the first of the ten years. So, one tenth, or £20,000 of the gain is treated as exempt under that heading;
- secondly, where you have a valid claim to main residence relief for any of your period of ownership, you get the last eighteen months treated as exempt automatically. So, eighteen months’ worth of gain (which is done on a strict time-apportionment basis) means another £30,000 comes off the taxable gain as being exempt under main residence relief; and
- finally, because the property has been let to tenants for the rest of the time, there is the so-called ‘letting relief’, which can exempt a further up to £40,000 of gain (or an amount equal to the exempt portion, if this is less). In Matt’s case, the cap applies, so he is able to deduct £40,000 letting relief from the gain.
So, let’s summarise the position:
£’000
Gain before reliefs 200
One year’s actual occupation as a residence –
deemed to be as a main residence under the election (20)
Last 18 months (30)
Letting relief (40)
Taxable gain before annual exemption 110
In total, then, the tax on this, at 28%, has been brought down from about £53,000 to about £28,000, taking into account the availability of the annual exemption – that is, Matt has saved CGT of around £25,000 simply because of some fairly occasional and desultory visits to the flat during the first year in which he owned it. Pretty impressive.
A common misunderstanding
People often misunderstand the precise status of a main residence election, as in Matt’s case above, and think that this constitutes some kind of pretence that you are living in the elected property as your actual main residence. Lots of clients ask me, for example, whether they should go on the local voters list, send out change of address cards, make sure that utility bills are in their names, etc, etc. But this is to get the wrong end of the stick as far as the rules are concerned.
What the rules say is that, where a person has two or more residences, he will normally achieve CGT exemption on the residence which is the actual centre of his existence: I sometimes describe this as the house where he keeps his Bob Dylan records! This is a question of fact. That is, if there were ever any dispute in the matter with HMRC, you would need to muster whatever evidence you have about your actual pattern of life, including how much time you spent in each of your residences, where you kept your most important possessions, and where you fundamentally regarded as being your ‘home’. It’s not unusual for large sums of tax to hang on such vague and nebulous criteria, in fact.
With a main residence election in place, however, all of that goes out of the window. The main residence election allows you to nominate one of your residences to be treated as your exempt residence regardless of the facts.
So, putting in a main residence election, in Matt’s case, for the London flat, is definitely not a case of telling the taxman that this property is your actual main residence. If anything, it’s the opposite; you are saying to HMRC that this property is not your main residence, but you want it to be treated as if it were under a special legal fiction which the statute allows.
The ‘quality’ of residence
No, what is likely to be in dispute, if anything, where a main residence election has been put in, is whether the property concerned is a ‘residence’ of the taxpayer at all. Articles have appeared recently in Property Tax Insider summarising the effect of recent tribunal decisions on this question, and the phrase about the ‘quality’ of the taxpayer’s occupation of the property comes from the judgments in these cases. Mark McLaughlin’s articles in Property Tax Insider in April 2017, and in Tax Insider in July 2017, analyse the cases of Moore, Bradley, and Oliver, all of which are decisions which have been published in the last ten years.
In Oliver, as Mark pointed out, the judge made a distinction between ‘staying’ in a property and residing there. The decision in that case was that he was only ‘staying’ in the property and was therefore not eligible for relief. As so often in tax, as I’ve mentioned above, a lot of money can hang on a fairly subtle distinction, or, one might cynically conclude in some cases, what the judge had for breakfast that morning!
In my hypothetical case of Matt, the taxman didn’t query the election, or the quality of his residence, but if he had, it would have been important for him to have been able to prove that it was truly a second home and not somewhere he was occasionally visiting or camping out in.
The evidence
The moral to be derived from the Oliver case, derived ultimately from the case of Goodwin v Curtis [1998] STC 475, is that there should be an assumption of permanence, and a degree of continuity or expectation of continuity. So how, about ten years after the event, could Matt have possibly proved this if the inspector had queried it? Here are a few ideas as to the evidence you could collect and retain:
- tedious though it no doubt would be, maintaining a diary showing periods of occupation would be good evidence;
- if any post is addressed to the taxpayer at the ‘second home’, retain the post and the envelopes in which it came;
- take plentiful photographs of the interior of the property showing that it is fully furnished, and has personal possessions lying around;
- if you have a house-warming party, or indeed any kind of party, in the property, this will indicate that it is more of a residence than a place where you are camping. Take plenty of photographs of these parties showing everyone making themselves very much at home;
- refer to the property appropriately in any letters, emails, or even texts, and of course make sure that you retain hard copies of these;
- retain, similarly, hard copies of any communications from others (perhaps stronger evidence), which refer to the property appropriately; and
- to back up the diary, keep any evidence of travel to the property or residence at the property, for example, train tickets or theatre tickets for places of entertainment near the second home.
Practical Tip:
Above all, use your imagination in gathering and retaining documentary evidence. It could save you a lot of money in the future!
