Posted by James Pearson on 10 Jan 2013

Capital Gains on Residential Property

It is commonly known that there is an exemption from capital gains tax for the sale by a person of their main residence. This rule is not quite as simple as it seems and a number of quirks exist that can help reduce your exposure to residential property tax.

Private Residence Election

One point to consider is that if you have two or more residences, you can elect which is your main residence. For the election to work it is important that you are electing between two properties in which you reside, not just that you own two properties in which you could reside. For example, if you own and live in one property, but have a second property which you have let out but is now empty, you can’t elect for the second property to be your main residence. However, if you resided in both properties, perhaps at different times of the week, and your residence of both properties was of sufficient quality to satisfy HMRC, you could elect the property of your choice to be the main residence for capital gains tax purposes. As well as exempting the period of residence from capital gains tax, any property that has at any time been your main residence should have the last three years of ownership exempted too.

HMRC has recently challenged an election on the grounds that circumstances clearly showed which property was the taxpayer’s main residence and it was not the residence that had been elected. HMRC’s challenge was not allowed as the law only specifies that the property that is elected must be a residence of the taxpayer, not that it must be the taxpayer’s main residence.

You cannot elect for a residence to be your main residence for a period that starts more than two years before the date of the election. If you have two potential residences and do not elect which is your main residence, HMRC will decide for you.

Gifting Buy To Let Properties

The interaction of the rule exempting the last three years of ownership of a property that has at any time been the owner’s main residence and the rules covering the transfers between married couples (and civil partners) can potentially exempt the whole gain on a buy to let property, even if it has been owned for more than three years.

Gifts between a husband and wife (or civil partners) are always deemed to take place at a price that means no capital gain or loss is made. This means that the recipient is effectively treated as having purchased the property at the same price as the disposing spouse did.

Where the gift being transferred is the disposing spouse’s residence, the recipient is also treated as having the same ownership history as the disposing spouse. This means that such a transfer can’t be used to avoid tax as both taxpayers would be in the same position when selling the property to a third party. However, if the property being transferred is not the taxpayer’s residence, the ownership history is not transferred, meaning that if the property becomes the recipient’s main residence and is then sold within three years, no capital gains tax will be payable at any point.

For example, if Richard has owned a property for 10 years, having let it out during that period, and then lives in it as his main residence for a short period with his wife Sally before selling the property, the last three years of ownership will be exempt from tax. This means that 7/10ths of the gain on disposal will be taxable.

If Richard instead gave the property to Sally shortly after they took up residence in the property, Sally would effectively be treated by HMRC as having purchased the property for the same price that Richard did, and at the same time. If she then sold the property to a third party she would be taxable on the same gain as Richard was above. This is because she would effectively be treated as having purchased the property for the same price at the same time, and with the same ownership history.

However, if Richard gave the property to Sally shortly before taking up residence in the property, Sally would be treated as having acquired the property for the same price that Richard did, but the ownership history would start afresh. Since the property would be Sally’s residence, the last three years of ownership would be exempt. Consequently if she sold the property within three years of the gift, no capital gains tax would be paid.

Exchanging Interests

In a situation whereby two people own the same property or land and are not husband and wife (or civil partners) tax would normally be charged on any transfer of interest in the property between those two owners. This would cause problems if the two owners had differing opinions on what to do with the property, as separating ownership would lead to a tax charge.

A tax relief exists to prevent a tax charge where interests are effectively exchanged, resulting in the two owners of the property instead having an absolute interest in specific parts of the property. For example, if a plot of land is jointly owned by two individuals (an example would be siblings who inherited the land together) they would legally each have rights over the whole plot. If one owner wanted to develop the land and the other did not, they would have a problem. A solution would be to exchange their interests in half the land meaning that instead of having a joint interest in the whole site, they would have an absolute interest in a specific half of the land each. This would allow one owner to develop their half of the land in isolation without impacting on the other.

However, care must be taken, as the relief may not be available if the land in question includes the private residence of one (but not all) of the owners exchanging interests. This also includes a situation in which one of the owners occupies the property as their main residence at any point within 6 years after the exchange.

What does this mean for Capital Gains on Residential Property

The taxation of property disposals is a complicated area and one in which a mistimed election or failing to meet every condition allowing a relief can lead to substantial taxation consequences.

Contact Tax Innovations

If you would like any advice regarding the above article or would simply like to discuss other ways in which we could help you or your business, please contact us on 01962 856 990 or customerservice@taxinnovations.com.