Rob Noble Warren, founder of Independence Financial Planning, looks at capital gains tax charges on a second property, and how to avoid them
With most clients thinking wistfully of another home in the sun, at some time they are going to become aware that on the sale of their second property, there will be a capital gains tax charge.
'No problem' is the thinking. 'Just claim that the second property became your main property at some time and then switch it back again within five years.'
But it is not quite so easy as that.
The motivation for making a claim is to secure 'only or main residence relief' for the last three years of ownership as 'exempt' (plus the time spent with that property as the main residence - also 'exempt'). In addition, there is 'lettings relief' too, if the property has been let at any time. The amount of lettings relief is detailed in TCGA 1992 s 223(4) and is effectively the lowest of three numbers:
the amount of the only or main residence relief;
the gain arising by reason of the letting;
Those three reliefs (the 'main residence' period; the last three years; and up to £40,000) do a great deal to reduce gains tax on second properties. The gain on the property is reduced pro-rata for the years that were exemptand divided by the total years of ownership. Then deduct from that gain up to £40,000 'lettings relief'.
A case study
David Hartley owns his own marketing consultancy, is 48, and eagerly trips down to his Cornish cottage for a week at a time. The cost of his £150,000 mortgage on that property is offset somewhat by the £6,000pa he receives in lettings. But it is not the income tax that bothers him; it is the capital gains tax. If he needs to sell and buy another, what would be his tax liability?
The trouble is that he has not made a 'main residence' election and now he is out of time. There is a time limit of two years during which the claim must be made by lodging an election under TCGA 1992, s 222(5), from the date when there is doubt as to which was his the main residence. That would be from the point when he bought the Cornish property, and before the first tenants moved in, sometime in 1995. Since he is not living there now, he cannot make the election, and he is going to miss out on the 'lettings relief'.
However, and weirdly, he might still qualify for the three years exempt. Once a property has been the taxpayer's main residence, whether by nomination or an analysis of the facts, the gain attributable to the last 36 months will always be capital gains tax-free; there is no requirement for the property to actually be an occupied residence during this 36-month period. Questioning the client, the facts get a little hazy:
"In 1995, we were starting the business, and my younger son was starting school in Reigate. We did spend some time down in Cornwall, but we were doing the property up rather than living there. We were not looking to move there permanently."
"So how do you feel about living there now?" we asked.
"It is something we are considering. But we want to sell the current property and buy another one in Cornwall first."
In these circumstances, even Extra-statutory Concession D49 ('Private residence relief - short delay by owner occupier in taking up residence') won't help. This gives concessionary relief where there has been a delay in taking up occupation of a property as a result of refurbishment work. In the first case, D49 has to be claimed within two years, and in the second, it looks like the Cornish property never was his main residence. It looked like Mr. Hartley was going to have to pay gains tax, less allowances on the sale price £350,000 less his purchase price £150,000, and it looked like here was nothing we could do about it.
"There is £50,000 of tax at stake here." we said. "What we would like to do is suggest a way in which you can re-arrange the timing of what you'll do anyway to qualify for lettings relief. The election for main residence relief has to be made within two years of a real question arising as to which is your main residence, but it is not restricted to just one occasion. So if your London house becomes unavailable for living in, and you all have to troop down to Cornwall even for a few weeks, then another two-year time limit for making a 'main residence' claim arises. I was wondering, do you have any repairs or improvements you have to make to your London house that mean you can't live there - something like replacing the roof, or a complete re-wiring job, or perhaps you would consider letting it out for a while?"
"Because if you do, then your London house becomes unavailable, and then you can make your main election claim for the Cornish property, and then you get your lettings relief, and the last three years exempt period, and your gains tax problem goes away."
Mr. Hartley smiled slowly.
Marcus Brookes appointed CIO
In association with Professional Adviser
Mortgages Market Study
Latest news and analysis