A gain arising on the disposal of a residential property may give rise to a capital gains tax (CGT) liability. However, a valuable tax relief called private residence relief (PRR) automatically applies on the sale of one’s main home and this relief may exempt all or part of the gain which arises.
How it works
The relief applies to the disposal of a 'dwelling house' which is, or has been, the only or main residence of an individual.
A ‘dwelling house’ is not defined by legislation, but there is a body of case law that can provide guidance. In the majority of cases, the whole building in which an individual lives will be the dwelling house. However in some cases, the dwelling house may comprise not just the main building, but also relevant buildings adjoining the main building. For example, a garage or an outbuilding used as part of the household may also qualify.
Gardens and grounds which fall within a permitted area also qualify for the relief. The permitted area is defined in the legislation as half a hectare, which includes the area of the house occupied. However, HMRC may permit a larger area to qualify provided that it is satisfied that the area is required for the 'reasonable enjoyment' of the property.
HMRC has not given any guidance about how long a taxpayer must live in a property for that to constitute actual occupation as his/her only or main residence. Instead it will look at the individual facts and circumstances of each case. For example, a few weeks of occupation after purchase may not qualify, but returning to a property for a few weeks after prior occupation in the past may be treated as resuming occupation. The important thing is that the taxpayer must satisfy HMRC that for that short period the property was his/her home. Case law has shown that HMRC will look at the quality of the occupation rather than the physical time period. The First-tier Tax Tribunal has recently stated that in order to have quality of residence, the occupation of the house should constitute not only sleeping, but also periods of ‘living’ - being cooking, eating a meal sitting down, and generally spending periods of leisure time at the house.
If any part of the house is used exclusively for business purposes, the relevant proportion of any gain made on sale will not qualify for relief.
If you have more than one residence during any period, it becomes necessary to decide which is your main residence. You could do this by giving notice to HMRC within two years of the time you occupied an additional property as your residence, or the time you changed your combination of properties. In the absence of such a notice the matter is decided on the facts of each case.
Marriage and PRR
Married couples and civil partners can only have one main residence between them. If at the date of marriage, the two parties each own a residence and the couple thereafter continue to use both properties as residences, they can jointly nominate which of the properties is to be treated as their qualifying residence for PRR purposes. The default CGT position will be that property is owned equally between the spouses. The two year period for making the nomination commences on the date of marriage. The effect of marriage is, therefore, that one property ceases to qualify for PRR and becomes exposed to CGT. The final 18 months of ownership of the now exposed property will be eligible for PRR (see below).
Where a husband and wife are living together for any part of a tax year, transfers of chargeable assets in that year are automatically treated as made on a no gain, no loss basis for CGT purposes. The effect of this provision is that the transferee spouse inherits the historical CGT base cost of the transferor spouse for the purposes of calculating a gain on a future disposal. On separation, the transferor spouse can claim continuing PRR for the period from the date of ceasing to occupy the property up to the date of transfer if the property continues to be the transferee spouse’s main residence, provided that the transferor spouse has not elected for another property to be their main residence for any part of that period.
The tax calculation
The law seeks to confine PRR to the occupation of a dwelling-house as a place of residence, and therefore attacks cases where the taxpayer’s acquisition, or some later expenditure on the property, was “wholly or partly” for the purpose of realising a gain. In such cases PRR is denied altogether.
Broadly, the gain eligible for relief is calculated as follows:
total gain made on sale x periods of occupation
total period of ownership
Certain periods of absence may be treated as actual occupation meaning that, in some cases, the property may still qualify for relief in full.
Qualifying periods of absence
The following periods of absence are treated as periods of actual occupation when calculating the gain eligible for relief:
- Any periods of absence for whatever reason not exceeding three years in total
- Any period of absence when employed outside the UK
- Any periods not exceeding four years in total due to certain employment requirements.
In order for these periods of absence to qualify, there must be a time both before and after the absence when the dwelling house is the individual's only or main residence. However, absences due to employment will qualify even if the individual does not return to the dwelling house afterwards if the reason for not returning is that their employment requires them to live elsewhere.
Furthermore, any period of absence when living in job-related accommodation will qualify for PRR provided there is an intention to occupy the dwelling as a main residence in due course.
If a property is not immediately occupied when it is first acquired, for example because essential repairs are required, HMRC will, by concession, allow a period of up to one year before commencement of occupation to be treated as a period of actual occupation as long as the house is then occupied as the only or main residence of the taxpayer. In exceptional cases, this period may be extended to two years.
Final period exemption
Provided a property has been the only or main residence at some point during the period of ownership, the final 18 months of ownership (this is expected to change to the final 9 months for property disposals from 6 April 2020) will qualify for relief, regardless of how the property is used during that time. This period is extended to 36 months in certain circumstances, for example when a person is a long term resident in a care home.
Lettings relief is available where PRR is restricted when all or part of a residence has been let as residential accommodation. Lettings relief is useful for individuals who have difficulty selling their former residence and are obliged to rent it out while trying to sell it. Under the current rules, a maximum of £40,000 of gain per owner is exempt from CGT if a home which has at some time been the owner's main residence has also been rented out. From 6 April 2020, lettings relief will only be available where the owner is in shared occupancy with the tenant.
Example calculation with some of the qualifying periods
P purchased a house on 1 June 2005 and sold it on 31 May 2018 (ie an ownership period of 13 years). It was occupied by P as his main residence from 1 June 2005 to 31 May 2011 (six years). It was then let as residential accommodation from 1 June 2011 to 31 May 2014 (three years). It was empty until it was sold at a gain of £150,000.
PRR and UK tax residence
As a result of the introduction of CGT for non-residents on the disposal of residential property, the PRR rules were amended with effect from 6 April 2015. The changes affect UK-resident individuals as well as overseas residents.
The PRR rules were amended so that a property may only be treated as an individual’s main residence for a tax year where the person or spouse has either been tax resident in the same country as the property for that tax year, or stayed overnight in the property at least 90 times in that tax year. The new rules apply to a UK resident individual disposing of an overseas residence just as they do to a non-UK resident disposing of a UK residence.
Any night spent by an individual’s spouse or civil partner in the property may be counted as a night spent by the individual in that property (although a night cannot be counted twice). Where an individual has two or more residences in the same country, the number of overnight stays at those properties can be aggregated for the purpose of the 90 day test.
When reviewing the availability of PRR and deciding on the number of nights to stay in a particular property, consideration should be given to the possible impact this may have on your residence status under the statutory residence test.
How can we help?
The tax implications of selling your residential property can be complicated and specialist advice should be sought. BDO LLP can advise you on all aspects of obtaining this valuable capital gains tax relief. From analysing whether the relief is available, to measuring the extent of the relief, to finally completing all of the required administrative processes in order to obtain the relief.
Please get in touch with your usual contact or Sam Dewes if you are contemplating a property purchase or sale and would like more information on the tax issues.