CGT - Home hints for taxpayers

Matthew Hutton offers a few tips on private residence relief from capital gains tax

The relief from capital gains tax for a person's only or main residence is well-known, enshrined in the legislation since the tax was introduced in 1965. The relief's details are not always straightforward, albeit contained in just five sections of statute (ss 222-226, Taxation of Chargeable Gains Act 1992) as amplified by case law and Inland Revenue extra-statutory concessions and statements of practice. It is vital that entitlement to the relief is maximised and is not prejudiced by error or omission. I shall consider five points here. All statutory references are to TCGA 1992.

Garden or grounds

The exemption in s 222(1) deals separately with the dwelling-house and the garden or grounds. Exemption for the latter is given only up to the 'permitted area', which is either 0.5 of a hectare (1.23 acres) or such larger area as is required for the reasonable enjoyment of the dwelling-house as a residence. The point is likely to be in issue only where the disposal of the garden or grounds does give rise to a gain, typically for development purposes.

Conceptually, the issue is the same whether there is a part-disposal of garden or grounds with the house being retained or whether the whole property is sold, although cosmetically the point may be easier to argue in the latter case. The problem with the former is the typical Revenue argument that if the taxpayer is prepared to sell part of the garden but wants to continue living in the house, surely he cannot argue that that larger area is required for the reasonable enjoyment of the house as a residence. The test is objective and not subjective - eg, an argument that with advancing years the taxpayer can no longer keep up the garden will not be accepted.

A recent case, Longson v Baker, has considered the meaning of the permitted area. On 16 November 2000, the High Court upheld the special commissioner's denial of the relief claimed on an area of some 18 acres, 'needed', it was argued, for stabling and grazing the family's horses. The test was confirmed to be an objective one, and in this case the larger area was not 'required' within the meaning of the statute.

Interesting questions of apportionment may arise if a larger area is sold and only part of it is agreed to attract the exemption: s 222(4) prescribes that it is that area which would be the most suitable for occupation and enjoyment with the dwelling-house.

One stratagem that does not work is the idea of selling to a developer, separately, the house for the bulk of the consideration and the garden for such consideration as will not attract a chargeable gain. Even though the two parties are independent they cease to be negotiating at arm's length once the consideration attributed to two or more separate parts of the transaction varies from what might be reasonably attributable on an arm's length basis. That then entitles the Revenue under s 17(1)(a) to apply market value to each part. The practical solution could be to attribute as much as is reasonably justifiable to the garden or grounds within the protection of s 222 - thus, it is hoped, vitiating a Revenue challenge by accepting a measure of tax liability on the garden.

What is important is that at the time the garden is sold the taxpayer still owns and preferably occupies the house (see Varty v Lynes 51 TC 419 and Tax Bulletin, August 1994).

The only or main residence

The position is quite straightforward if the taxpayer owns and has only one residence, since there will be only one property the relief can apply to. If he has more than one, the relief for any period will apply to his 'main residence'. Subject to an election, this issue will be determined on the facts, though note first that the relief contains no territorial limitation. So someone who is UK-resident but foreign domiciled and taxable on the remittance basis cannot, in the absence of an election, claim as exempt a gain on the UK house, if as a matter of fact the foreign house is his main residence. (This applies even if no UK taxable gain would arise on its disposal.)

Further, the Revenue maintains that a property the taxpayer occupies as tenant (though not as licensee) is or can be a residence of his for purposes of the relief. If, therefore, the taxpayer owns one property and rents another that on the facts is his main one, he will (in the absence of a valid election) get no relief on a disposal of the owned property at a gain.

Assume that each of two or more properties is a residence (ie, there is some continuity of substantive occupation over a period of time). It is possible for a taxpayer to elect conclusively under s 222(5)(a) that a particular residence shall for a period of time be treated as his main one, for purposes of the main residence exemption. However, following Griffin v Craig-Harvey [1994] STC 54, the election must be made within two years after the acquisition of the second property as a residence.

Once the two-year period has expired, the taxpayer cannot make an election as between that combination of residences. The acquisition of a further residence (even a property that he rents) would start a new two-year period running as between the then combination. Any election can go back for up to two years, though not of course before the relevant combination of properties has been acquired.

Once an election has been made it can be varied, again with two-year retrospective effect. This power to vary underlines the importance of making an election wherever possible, even if it is in favour of the factual main residence.

The question of elections needs to be considered carefully on both marriage and separation. This is because, while married and living together, husband and wife can have only one main residence exemption between them (s 226(6)(a)).

The period of ownership

The 'period of ownership' does not include any period before 31 March 1982. The legislation looks at the period of ownership and (subject to permitted periods of absence - see below) gives relief on the proportion of the gain borne by the period of occupation to the period of ownership. The 'period of occupation' for this purpose always includes the last 36 months, regardless of whether that period of ownership is of only or main residence occupation. (This applies where the property is not then occupied for exclusively business purposes - s 223(2)(a)).

Accordingly, if the dwelling has at some time in the period of owner-ship (even before 1982) been the only or main residence, the gain attributable to the last 36 months will always qualify for relief. This underlines the importance of timely use of elections and switching elections away from the property to be sold, ideally 36 months before a binding contract is executed (which under s 28(1) triggers the date of disposal).

Equally, by ESC D49 the taxpayer is allowed to treat a period of non-occupation at the beginning of his period of ownership as if it were occupation. This applies where:

•   he acquires land and has a house built that he uses as his only or main residence; or

•   he purchases an existing house and before using it as his only or main residence arranges for alterations or redecoration or completes the necessary steps for disposing of his previous residence.

If there are good reasons, that are outside the taxpayer's control, for the period exceeding a year, it can be extended for up to a maximum of another 12 months. Rather like the last 36 months, a taxpayer can during that 12-month period in effect have main residence relief running on two properties.

If part of the gain is chargeable, the Revenue will normally calculate the chargeable and exempt parts under s 224(2) on a straight-line apportionment basis, precluding any argument by the taxpayer that the bulk of the gain arose during a period of residence.

Permitted absences

Certain periods of non-occupation are allowed under s 223(3) without prejudicing main residence relief, ie:

•   a period or periods not exceeding three years in total;

•   any period throughout which the taxpayer was employed outside the UK; and

•   any period or periods not exceeding four years in total, throughout which the taxpayer could not reside in the property, in consequence either of the situation of his place of work or of any condition imposed by his employer requiring him to reside elsewhere (being a condition reasonably imposed to secure effective performance of his duties).

The statutory rules are extended by two ESCs - D3 and D4. These periods are cumulative.

For any of them to apply, there must be a 'time' both before and after the relevant period when the property was as a matter of fact the only or main residence. Here the Revenue stated in its Tax Bulletin of August 1994 that it does not attempt to impose a minimum period, and prefers to take account of quality rather than quantity of occupation. As a rule of thumb, a period of three months may perhaps be taken as a reasonable one, although less than that may well suffice in a particular case.

Relief for lettings

If part of the gain is attributable to a period of letting (of whole or part of the house), it is exempt under s 223(4) insofar as the gain does not exceed the lesser of:

•   the tax-free part of the gain; and

•   £40,000.

This means that, provided that no more than half the house is let throughout the period of ownership or the whole house is let for no more than half the period, there is no restriction on the relief, given that the attributable gain is no more than £40,000. If the gain exceeds £40,000, or more than half of the house is let throughout the period, or the whole house is let for more than half the period, the relief will be restricted. For the relief to be available, the let accommodation must form part of the main residence. There can sometimes be an interesting question as to whether the part let is a separate dwelling in its own right - eg, a self-contained flat within the house with its own access. A useful statement of practice, 14/80, discusses the issues.

Interestingly, this relief for lettings is available to each of husband and wife.

Matthew Hutton MA(Oxon) FTII AIIT TEP is the author of Tolley's Tax Planning for Private Residences (3rd edition), available from Butterworths Tolley (tel: 020 8662 2000) at £49.95.

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