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Malcolm Finney, author of 'Personal Tax Planning: Principles and Practice', looks at the UK tax implications for an individual's only or main residence.

Background

For many individuals the family home or main residence constitutes their most valuable asset. It is an asset in respect of which any capital gain arising on a disposal is in principle exempt from Capital Gains Tax (CGT) (TCGA 1992 ss 222 and 223). There are, however, no corresponding tax reliefs/exemptions with respect to Inheritance Tax (IHT). Similarly, rental income which arises from the letting out of the home, during periods of absence, is subject to Income Tax (ITTOIA 2005 Part 3).

It is an asset that, for many, is held jointly whether by husband and wife, co-habitees, or just friends.
 
Nevertheless, while in principle any capital gain arising on a disposal of the property is exempt from CGT, the legislation is littered with caveats and thus not all disposals may necessarily be effected without a charge to CGT arising. Where a CGT charge arises, the Annual Exempt Amount (TCGA 1992 s 3; £10,600 for the tax year 2011–2012) is available to reduce the charge.

Where an IHT charge arises it is likely to be relatively material due to the typical value of the home compared to other family assets. It is not therefore surprising that various ‘schemes’ have been developed, designed to allow parents to gift the home, so as to exclude it from their estate on death for IHT purposes, yet still allow them to continue to live in it until death.

Unfortunately, a number of these schemes are no longer viable.
 
Inter-spouse transfers of interests in the home, as with other property, are usually exempt both for CGT and IHT purposes (TCGA 1992 s 58 and IHTA 1984 s 18).

This chapter examines the key CGT and IHT issues affecting planning for the family home including some of the associated tax issues arising on divorce.

Capital Gains Tax

For CGT purposes the date of disposal of land is the date of ‘exchange of contracts’ not the date of ‘completion’ (assuming the contract is not conditional which is usually the case for residential properties; TCGA 1992 s 28).

Overview

The CGT legislation (TCGA 1992 Part VII) uses the terms ‘private residence’, ‘residence’ and ‘dwelling house’.

More specifically, the legislation refers to (TCGA 1992 s 222):

‘an interest in …a  dwelling house or part of a dwelling house which is, or has at any time in his period of ownership been, his only or main residence.’

The statute continues (TCGA 1992 s 223):

‘No part of a gain ... shall be a chargeable gain if the dwelling house or part of a dwelling-house has been the individual’s only or main residence throughout the period of ownership or throughout the period of ownership except for all or any part of the last 36 months of that period’.

Any period of ownership before 31 March 1982 is to be ignored (TCGA 1992 s 223) and, irrespective of all circumstances, the capital gain attributable to the last 36 months of ownership is always exempt from CGT. The reference to any ‘gain’ not being a ‘chargeable gain’ means that the gain on disposal is exempt from CGT. This exemption extends to (TCGA 1992 s 222):

‘land which he has for his own occupation and enjoyment with that residence as its garden or grounds up to the permitted area [i.e., 0.5 hectare]’.

The ‘permitted area’ may be greater than 0.5 hectare where the larger area is (TCGA 1992 s 222):

‘required for the reasonable enjoyment of the dwelling house as a residence, having regard to the size and character of the dwelling house’.

Two or More Residences of the Individual

The use of the phrase ‘only or main residence’ suggests that an individual may have more than one residence (which is in fact correct) and the term ‘individual’ which appears in the legislation (TCGA 1992 ss 222 and 223) suggests that perhaps only individuals may qualify for exemption from CGT (this is incorrect as trustees of a settlement and executors administering a deceased’s estate may also qualify; TCGA 1992 ss 225 and 225A).

Where an individual in fact has two or more residences it is possible to elect which of the various residences is to be treated as the main residence for CGT exemption purposes. Any such election can be varied at a later date depending upon circumstances.

Non-UK Property

There is no apparent territorial restriction contained within the legislation and therefore a residence outside the UK may qualify as the individual’s only or main residence in the same manner as a residence within the UK. This may, in particular, apply in the case of a non-UK domiciled but UK resident individual who may own at least two residences, one in the UK and one in the country of nationality.

However, for the UK domiciled and UK resident individual who owns a home in the UK and a holiday home in, say, Spain it is unlikely that the latter qualifies as a ‘residence’ and thus such an individual does not have two ‘residences’ and any election is not then either necessary or possible.

Example 1

Toby and Helen Blue own a detached property in Yorkshire where they, together with their three children, live for most of the time.

Three years ago they purchased an apartment in Marbella, Spain, which they tend to use for three months each summer.

Although Toby and Helen own two properties it is unlikely that the apartment in Marbella qualifies as a ‘residence’.

Example 2

Tobias and Maria Barcelona are both non-UK domiciled but UK resident and jointly own a detached property in Barcelona, Spain.

Three years ago they purchased an apartment in London.

They spend roughly equal amounts of time in each property.

In this example it is likely that there are two ‘residences’. If this is so then it becomes necessary, for any periods of time, to identify which of the two properties qualifies as their ‘main’ residence for CGT purposes.

Tobias and Maria can elect which of the two properties is, for CGT purposes, to be treated as their ‘main’ residence.

It is probably sensible for Tobias and Maria to elect for their UK property to be their main residence thus avoiding a CGT charge on sale. Any capital gain arising on the sale of their Spanish property is subject to CGT but as they are non-UK domiciled any such gain is only in fact taxable in the UK if and when any of the sale proceeds are remitted to the UK.

Married Couples and Cohabitees

A married couple who are living together can only have one main residence (TCGA 1992 s 222). Thus, a couple who are married but not living together (e.g., formally separated or divorced) may each have a main residence.
 
For cohabitees each cohabitee may have a main residence (perhaps this is one of the few tax advantages available to cohabitees compared to married couples).

Total v Partial Capital Gains Tax Exemption

For the capital gain arising on the disposal of a sole or main residence to be completely exempt requires that the property is the sole or main residence throughout the whole period of ownership of the property. In the event that this is not the case (e.g., for part of the ownership period the property is let; the individual perhaps lives elsewhere; or the property is left empty) some part of the capital gain on disposal may fall subject to CGT; typically, a time apportionment approach is adopted when computing any capital gain.

Example 3

Gregory Pick owned a UK property for 20 years following which the property was sold for £500,000 (purchase cost £100,000).

For eight years of this 20-year ownership period Gregory lived in his Florida villa letting out his UK property in the meantime.

On the sale of the UK property, of the 20-year period of ownership the property qualifies as Gregory’s sole or main residence for 15 years (i.e., the 12 years of actual occupation plus the last 36 months). Thus:

Exempt capital gain = 15/20ths of £400,000 = £300,000.

Taxable capital gain = 5/20ths of £400,000 = £100,000.

However, in addition, certain periods of absence from the property may also be deemed to be periods of occupation and thus no loss of CGT exemption for such periods occurs; furthermore, where the home is let ‘lettings relief’ may be available.
 
It is also necessary if the capital gain on disposal of the sole or main residence is to be completely exempt that the property is not either in whole or in part used exclusively for business purposes. If this is the case an apportionment of the capital gain on disposal is necessary with that relating to the business element constituting a capital gain subject to CGT.

Profit Motive

This issue is often overlooked. If an individual acquires a dwelling house for the purpose of disposing of it at a profit the sole or main residence (and lettings relief) CGT exemption is inapplicable. Thus, intention at the time of purchase is important. More specifically TCGA 1992 s 224 provides that:

‘[an exemption from CGT is inapplicable if] the acquisition of the dwelling house or part of a dwelling house was made wholly or partly for the purpose of realising a gain from the disposal of it’.

The above topics are now discussed in more detail.

Residence

Unless a property is in fact an individual’s residence no exemption on any gain arising on its disposal is possible. It is therefore important in the first instance to ascertain whether or not a particular property is, de facto, a residence of the individual.
 
Ownership, per se, is insufficient to cause a property to automatically qualify as an individual’s residence and a property which an individual does not own, but in which he resides, may still constitute a residence.
 
This might arise where, for example, the individual purchases a property which he lets out whilst he continues to live with his mother in a property she owns. In this case, his sole residence is that of his mother’s house (even though he owns no part of it) and the house he owns is not a residence of his, per se; in which case on disposal, a CGT charge arises.
 
In normal parlance a residence is, perhaps, a place where somebody lives on a day-to-day basis.
 
Whether a property is a residence of an individual is a question of fact to be determined in the light of all the surrounding circumstances.

Generally speaking, to qualify as an individual’s residence the property must be occupied and must be occupied with some degree of permanence. It is not necessary for the individual to live in the property literally every day but some degree of permanence is required. If an individual purchases a property and never in fact actually lives in the property it almost certainly does not qualify as a residence. Spending only the odd night in the property may also fail to cause the property to qualify as a residence.

Matters likely to be important to any determination of whether a particular property qualifies as a residence (or main residence) may include:

• length of ownership;
• number of nights spent at the property;
• address used for council tax, passport, driving licence and car registration;
• location of children’s school;
• location of workplace; and
• location of private possessions.

In the final analysis it is the ‘quality’ of the residence not ‘quantity’ which is important.

Example 4

Thomas Golding lives in a rented flat in London and the house which he owns in the country has been let out almost continually from the date of purchase. When the house has not been let, Thomas spends the odd night there.

Although Thomas does not own the flat, it qualifies as a residence.

The house is arguably not a residence of Thomas and thus on sale it is likely that the exemption from CGT will not apply.

Example 5

Thomas Golding’s brother, Gerald, also lives in a rented flat in London but also spends virtually every weekend at his house which he owns in the country.

Although, like Thomas, Gerald does not own the flat it qualifies as a residence.

However, in Gerald’s case, the house in the country is also a residence.

In this scenario Gerald has two residences and for CGT purposes it is necessary to ascertain which is his main residence (this is done by making an appropriate election).

Two or More Residences and the Election

Example 5 illustrates that an individual may have more than one residence over the same time period. However, in such cases only the main residence qualifies for CGT exemption and thus such needs to be determined.
 
It is possible for an individual in such circumstances to simply make an election pursuant to which he selects which of the two (or possibly more) residences is to be regarded as his main residence (TCGA 1992 s 222). Such an election is simply made in writing, duly signed, to HMRC, inter alia, stating the date from which the chosen residence is to be regarded as the main residence. This election has to be made within two years of the date from which the individual has two (or more) residences (TCGA 1992 s 222).

Should the individual fail to lodge such an election within the time provided the determination as to the individual’s main residence is made by HMRC on the facts (which may produce a different, and possibly less favourable, result than if the individual had settled the matter by lodging an election).

Example 6

Barbara Tomkins owns a house in the country where she resides and which she regards as her home.

She also owns a flat in London which she permanently lets out.

Barbara owns two properties but only the house qualifies as a residence and thus an election is not possible or indeed needed.

Example 7

Barbara Tomkins’ sister, Amelia, owns a house in the country where she spends every weekend.

She also owns a flat in London where she stays during the working week as she works in London and it is not possible to travel each day from her country house to London.

Amelia, unlike Barbara, owns two properties each of which qualifies as a residence.

Barbara would thus be well advised to make a formal election to determine which of her two residences she wants to be treated as her main residence.

Example 8

Alistair Duckling purchased his country house ten years ago in which he lives.

On 1 January 2006 he purchased a flat in London which he immediately let out on a two-year lease.

The acquisition of the flat in January 2006 has not given rise to Alistair having two residences (although he owns two properties) since he does not occupy the flat and thus no election is possible or needed.

On 1 January 2008, following the termination of the lease, Alistair begins to occupy the flat most days of the week as he now works in London but continues to spend weekends at his country house.

It is arguable that effective 1 January 2008 Alistair has two residences and it would thus be advisable that he lodge an election to determine which of the two residences is to be treated for CGT purposes as his main residence.

The election would need to be made on or before 31 December 2010.

Although the making of an election is to some extent a precautionary measure, and invariably in the individual’s interest to so do, it can also be used as a planning device.

Once an election is made it is not irrevocable and it can thus be subsequently varied. On a variation the time period to which the variation relates cannot commence more than two years prior thereto (i.e., prior to the date of the variation).

Example 9

Simon Plus owns two properties: a house in the country and a flat in London. Both qualify as residences and Simon has made a timely election in favour of his country house (on which he anticipates there will be the larger gain should a sale be effected).

On 1 August 2008 Simon sells his flat on which a capital gain arises with no exemption. Simon therefore lodges, on 1 August, a variation under which he elects that his flat, not his house, is to be regarded as his main residence.

This later variation is effective from two years earlier (i.e., 1 August 2006). As the flat is now to be regarded as his main residence Simon is entitled to treat the last 36 months of ownership of the flat as his main residence. Thus, the capital gain attributable to the period 1 August 2005 to 1 August 2008 is exempt from CGT (whereas without the variation no part of the capital gain on sale of the flat would be exempt).

On, say, 7 August 2008 Simon varies the latest election and elects for the house to be his main residence; this applies from 7 August 2006 (i.e., two years earlier).

The effect of the above is that his house is no longer his main residence but only for the period 1 August 2006 to 7 August 2006. On an eventual sale of the country house only the capital gain pro-rated to this one week will be subject to CGT.

In Example 9 it may be noted that the third election (i.e., the last election) is in fact lodged when Simon only has the one property, his house (i.e., at this time he does not have two residences, having sold the flat).

The point is, however, that the election relates to a period commencing two years earlier during which Simon does have two residences and thus in respect of which a valid election is possible.

In order for an election to be made an individual in principle needs to occupy at least two properties as a residence; ownership is irrelevant. However, HMRC are of the view that for an election to be valid the possibility of a capital gain subject to CGT arising must apply to both properties. Where one of the properties is occupied under a mere licence (e.g., where an individual lives in their parents’ house) HMRC’s view is that this does not represent an interest which is capable of giving rise to a CGT charge on disposal and thus no election in respect thereof is possible; HMRC require that the interest must be either a legal or equitable interest (either of which may precipitate a capital gain subject to CGT on disposal).

There are various categories of licence including bare licences and contractual licences. The former is simply a personal permission granted by, say, X to, say, Y permitting Y to enter X’s land; no consideration is provided by Y to X.

The latter differs from a bare licence as consideration passes from the licensee (Y in the above example) to licensor (X in the above example).

A licence is generally accepted as creating no interest in land; its creation transfers no interest in the land.

A lease (tenancy) on the other hand grants exclusive possession of the land (to the lessee or tenant); is for a fixed or periodic term; and under which the lessee (or tenant) pays to the lessor a premium (i.e., a lump sum) and/or periodical payments.

A lease, unlike a licence, creates a proprietary estate in the land on the part of the lessee and an election in respect thereof is possible.

An individual may thus have two residences one of which is owned and one of which is occupied under a short lease/tenancy agreement and thus a valid election is possible and indeed, in such situations, advisable. However, a short lease/tenancy agreement may have minimal value precipitating minimal (if not negligible) capital gain on disposal subject to CGT.

It may be that the individual is unaware of the need for an election where one property is occupied under a lease and its value is minimal and accordingly fails to lodge an election within the two-year time limit. HMRC provide by concession (ESC D21) that where this occurs the individual may still lodge an election (even if it is outside the two-year time limit) if it is lodged as soon as the individual realises that such an election is necessary (which normally arises on a disposal of the owned property).

Married Couples

As indicated above, a married couple who are living together are permitted only one main residence (TCGA 1992 s 222). Where a married couple owns more than one property, each of which qualifies as a residence, a formal election is advisable. Any such election is required to be signed by both spouses (TCGA 1992 s 222).

It is important to note that a married couple who are not living together (i.e., are separated) may each possess a main residence (as indeed can cohabitees).

Prior to marriage it is not unusual for each of the two individuals to own their own property with each property qualifying as the sole residence of the respective individual. On marriage one of the, now spouses, often moves into the residence of the other spouse with the property which is vacated no longer qualifying as a residence. However, this may not be the case and the married couple may continue to reside in both of the properties. Where it is arguable that both properties continue to qualify as residences an election should be made (and made within two years of the date of marriage - i.e., within two years of the commencement of the date both properties qualify as residences).

Where one of the properties is vacated and no longer qualifies as a residence (thus precluding the need for an election) if it is sold within 36 months of vacation no CGT arises (as the last 36 months of ownership are always treated as periods of occupation; TCGA 1992 s 223).

However, where the sale occurs after the 36-month period some part of the capital gain will be subject to CGT.

An alternative to an immediate sale of the property is to initially let it out and to then sell it at a later date. Where the sale is made more than 36 months after it is vacated as a residence some part of the capital gain falls subject to CGT albeit lettings relief will be available in respect of the period of the letting up to a maximum of £40,000 (TCGA 1992 s 223).

The above article is based on an extract from 'Personal Tax Planning: Principles and Practice', by Malcolm Finney, published by Bloomsbury Professional. For further information and to order the book, please visit Tax Boookshop (Personal Tax Planning: Principles and Practice, 2nd Edition).