The capital gains tax ( CGT) exemption for gains made on the sale of your
home is one of the most valuable reliefs .from which many people benefit
during their lifetime. The relief is well known: CGT exemption whatever
the level of the capital gain on the sale of any property that has been
your main residence. In this bulletin we look at the operation of
the relief and consider factors that may cause it to be restricted.

Several important basic points

Only a property occupied as a residence can qualify for the
exemption. An investment property in which you have never lived
would not qualify.

The term 'residence' can include outbuildings separate from the
main property but this is a difficult area. Please talk to us if
this is likely to be relevant to you.

'Occupying' as a residence requires a degree of permanence so that
living in a property for say, just two weeks with a view to
benefiting from the exemption is unlikely to work.

The exemption includes land that is for 'occupation and enjoyment
with the residence as its garden or grounds up to the permitted
area'. The permitted area is 1/2 a hectare including the site of
the property which equates to about 1 1/4 acres in old money!
Larger gardens and grounds may qualify but only if they are
appropriate to the size and character of the property and are
required for the reasonable enjoyment of it. This can be a difficult
test. In a recent court case the exemption was not given on land of
7 1/2 hectares attaching to a property. The owner said he needed that
land to enjoy the property because he was keen on horses and riding.
The courts decided that the owner's subjective liking for horses was
irrelevant and, applying an objective test, the land was not needed for
the reasonable enjoyment of the property.

Selling land separately

What if you want to sell off some of your garden for someone else to
build on? Will the exemption apply? In simple terms it will if you
continue to own the property with the rest of the garden and the total
original area was within the 1/2 a hectare limit.

Where the total area exceeds 1/2 a hectare and some is sold then you
would have to show that the part sold was needed for the reasonable
enjoyment of the property and this can clearly be difficult if you were
prepared to sell it off.

What if on the other hand you sell your house and part of the garden
and then at a later date sell the rest of the garden off separately, say
for development? Then you will not get the benefit of the exemption
on the second sale because the land is no longer part of your main
residence at the point of sale.

More than one residence

It is increasingly common for people to own more than one
residence. However an individual can only benefit from the CGT
exemption on one property at a time. In the case of a married couple,
there can only be one main residence for both. Where an individual
has two (or more) residences then an election can be made to
choose which should be the one to benefit from the CGT exemption
on sale. Note that the property need not be in the UK to benefit
although foreign tax implications may then need to be brought into the equation.

David has a property he lives in during the week and a country cottages
where he lives at weekends. A valid election may be made for the country
cottage to be exempt for CGT purposes. It does not matter that it is not the
main residence.

The election must normally be made within two years of acquiring a
second residence and the potential consequences of failure to elect
are shown in the case study appearing later.

Furthermore the case study demonstrates the beneficial rule that
allows CGT exemption for the last three years of ownership of a
property that has at some time been the main residence.

Case study

Wayne, a 40% taxpayer, acquired a home in 2000 in which he lived
full-time. In 2004 he bought a second home and divided his time
between the two properties.

Either property may qualify for the exemption as Wayne spends
time at each - i.e. they both count as 'residences'.

Choosing which property should benefit is not always easy since it
depends on which is the more likely to be sold and which is the
more likely to show a significant gain. Some crystal ball gazing may
be needed!

The choice of property needs to be made by election to the Inland
Revenue within two years of acquiring the second home. Missing this
time limit means that the Inland Revenue will decide on any future
sale which property was, as a question of fact, the main residence.

Wayne elects for the second property to be treated as his main
residence for CGT purposes. In 2010 he sells both properties realising
a gain of £100,000 on the first property and £150,000 on the second
property.

The gain on the second property is CGT-free because of the election
Part of the gain on the first property is exempt. Namely that relating to:

1. the four years before the second property was acquired (when the
first property was the only residence) and
2. the last three years of ownership which will always qualify providing
the property has been the main residence at some time.

In other words out of the ten years of ownership, a total of seven
qualify for the exemption. Therefore three tenths of the gain -
i.e. £30,000 will be taxable. Taper relief at 40% will reduce the
chargeable gain to £18,000. Assuming no other gains in the year, nearly
half of this (on current figures) would be covered by the annual exemption
giving a CGT liability of under £4,000. Not bad on total gains of £250,000.

Without the election, and the first property being treated as the main
residence throughout, Wayne would have found the gain on the first
proper1y wholly exempt and the gain on the second property wholly
chargeable. This could have resulted in a CGT liability of nearly £45,000
after taking into account taper relief at 20% and the annual exemption.
Failure to make an election can be an expensive mistake.

Business use

More and more people work from home these days. Does working from
home affect the CGT exemption on sale? The answer is simple - it may do!

Rather more helpfully the basic rule is that the exemption will be denied
to the extent that part of your home is used exclusively for business
purposes. In many cases of course the business use is not exclusive, your
office doubling as a spare bedroom for guests for example, in which case
there is not a problem.

Where there is exclusive business use then part of the gain on sale will be
chargeable rather than exempt. However this part of the gain may well be
eligible for business asset taper relief quite probably at 75% which will
serve to reduce the impact of any charge. As is all too often the case with
tax, the calculation is neither as simple nor as logical as you would expect
but we can talk you through the principles involved if this is of interest
to you. In any case it may well be that you plan to acquire a further property,
also with part for business use, in which case the business use element of
the gain can be deferred by 'rolling over' the gain against the cost of the
new property.

Residential letting

A further relief is given if your main residence has been let as
residential accommodation during the period of ownership. A case
study best demonstrates the operation of this.

Case study

Frank bought a property in 1990 and lived in it as his main residence
for eight years unti1 1998. Then he bought a second property which
immediately became his main residence and the first property was let
from then until its sale in 2004.

The gain on sale of the first property amounted to £210,000.

Exempt as main residence

1990-1998 8 years (actual occupation)
2001-2004 (last 3 years of ownership)
Total - 11 years

Gain exempt = 11/14 x £210,000 = £165,000

The balance of the gain (£45,000) relates to the period from 1998 to
2001. The property was let during this period and had previously been
Frank's main residence so that the letting exemption is available.
Although the gain relating to this period amounts to £45,000 the
exemption for letting is limited to a maximum of £40,000.

Overall £205,000 of Frank's gain is exempt leaving only £5,000
chargeable to tax and this is subject to taper relief and the annual
exemption so that it is unlikely he will have to pay any CGT.

The letting exemption can be very valuable but is only available on a
property that has been your main residence. It is not available on a 'buy
to let' property in which you never live.

Periods of absence

Certain other periods of absence from your main residence may also
qualify for CGT relief if say you have to leave your property to go and
work elsewhere in the UK or abroad. The availability of the exemption
depends on your circumstances and length of period of absence.
Please talk to us if this is relevant for you. We would be delighted to set
out the rules as they apply to your particular situation.

Trusts

The exemption is also available where a property is owned by trustees
and occupied by one of the beneficiaries as their main residence.

Until last December it was possible to transfer a property you owned
but which was not eligible for CGT main residence relief into a trust for
say the benefit of your adult children. Any gain could be deferred using
the gift relief provisions. One of your children could then live in the
property as their main residence and on sale the exemption would have
covered the entire gain.

The Inland Revenue has decided that this technique was being used as
a mechanism to avoid CGT and so has blocked the possibility of
combining gift relief with the main residence exemption in these
circumstances.

Conclusion

The main residence exemption continues to be one of the most valuable
CGT reliefs. However the operation of the relief is not always
straightforward nor its availability a foregone conclusion. Advance
planning can help enormously in identifying potential issues and
maximising the available relief.

If you feel you may have a problem with this issue and wish to discuss it call Stuart Atkinson on 01482 226791