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The purpose of this article is to explain some important aspects of the Private Residence Relief (PPR) and to discuss some common strategies that are used by investors to benefit from the relief.
How long before a property is classed as your Private Residence?
This is a very commonly asked question and the Inland Revenue has not given any specific guidance as to how long you need to live in a property before you can claim the relief.
How to show a property was or is your main residence
If you want to claim this relief then here are some pointers that will help you to convince the taxman that a property genuinely was your private residence.
a) Have utility bills in your own name at the property address.
b) Make the property address your voting address on the electoral register.
c) Be able to demonstrate that you bought furniture and furnishings for the property. Keep receipts and prove that bulky furniture was delivered to the property address under your name.
d) Have all bank statements delivered to the property address.
Frequently changing your PPR to grow a tax-free portfolio
Investing and maximising your PPR
A very popular strategy for helping to grow a tax-free portfolio is to have a property nominated as your main residence at some time prior to selling it.
However, it is important to understand that if you have a portfolio of properties and then decide to nominate each of your properties in turn, as your Private Residence, then the Inland Revenue could very well challenge you. In fact they are very likely to challenge you. They could challenge you on the basis that the reason for nominating your properties is to avoid paying tax.
Consider the following two case studies, which involve investors who let their properties.
Growing a Rolling Tax Free Property PortfolioThis is a good strategy for growing a small ‘rolling’ tax-free property portfolio. The aim of John and Aleesha is to sell a property three years after they have lived in it and avoid any CGT liability.
John and Aleesha decide to start investing in property and buy their first home, a two-bedroom terraced house, in 1995 for £50,000. They live in the house and then after three years (in 1998) decide to move to a bigger three-bedroom house. The cost of the new house is £145,000.
Instead of selling the house they rent out the two-bedroom house.
Again they live in the house for three years and then move into a new four-bedroom house with their two young children. AT the time of buying the three bedroom house they sell the two-bedroom house for £125,000 and rent out the three-bedroom house.
They have made a £75,000 tax-free profit on the sale of the two-bedroom house. This is because due it being their main residence they are able to claim the ’36 month rule’ relief to wipe-out any CGT liability.
They continue to live in this property for three years and then buy a bigger five-bedroom house. Again at the same time of buying the new house they sell the three-bedroom house for £245,000 and rent out the previous residence i.e. the four-bedroom house.
The CGT liability on the three-bedroom house is also zero because they claim the ’36 month rule’ once again. This means that they have made £100,000 profit on this house.
Also, from the sale of two houses, John and Aleesha have made £175,000 in tax-free income in just nine years. This equates to almost £20,000 of tax-free income on a yearly basis.
John and Aleesha continue to buy and sell a property every three years using this simple strategy.
Comments on using PPR to grow a tax free property portfolio
Now we will move onto the case study of Wallace. He has not done any tax planning and has just followed the normal buy-to-let route.
Case Study - Not making use of Principle Private ResidenceWallace starts to invest in property in 1995. He has his main residence and buys property A, a two-bedroom apartment off-plan at a cost of £65,000. Two years later he buys property B also off-plan for £85,00. Three years later in 2000 he buys his third property, property ‘C’, a three bedroom semi-detached property for £160,000.
In January 2005 he decides to sell his three investment properties and has the following gains:
Property A – Selling price £165,000 = £100,00 gain
Property B – Selling price £170,000 = £85,000 gain
Property C – Selling price £280,000 = £120,000 gain
This means that on his three investment properties he has a total gain of £305,000. Then he realises that he will be liable to pay CGT at 40% on a large part of his gain.
In order to minimise the CGT liability he considers moving into each of the properties for a ‘short’ i.e. 6 month period so that he can claim the generous tax breaks associated with PPR.
However although there is nothing to stop him from doing this, it is a very high-risk strategy. This is because if the Inland Revenue discovers that multiple properties have been nominated as the main residence prior to disposal then the sale will be challenged.
Wallace therefore decides not to take the risk of facing the wrath of the Inland Revenue, and therefore ends up selling his three properties and paying a tax bill in excess of £100,000!
Pitfalls of not planning use of Principle Private Residence Relief
Developing and maximising your PPR
Similar observations can also be made for property developers who decide to develop properties and re-sell them for a profit whilst living in them.
Timing and period of occupation is key here. This is because if you develop and re-sell quickly then the greater the chance there is that the Inland Revenue will challenge you.
Consider the following two case studies where Conan and Duke are both employed as property developers.
Case study - living in property as you develop it to make use of PPRConan then buys his next property and this takes longer to develop. He buys it for £80,000 and again spends £20,000 developing it before selling it for £200,00 three years later.
This time his taxable profit is £100,000 and again there is no CGT liability which means he has made £100,000 tax free.
Conan continues to use this strategy for the next 10 years after which he has sold another three properties and made an extra £500.000 tax-free.
Benefits of living in property you are developingOver a 15 year period Conan has bought and sold 5 properties, whilst living in them for a good length of time. Even if the Inland Revenue was to challenge him he is very likely to succeed, as he has just executed a very tax efficient saving strategy.
Now lets look at the situation for Duke.
Case study - Abuse of the PPR Rule when developing propertyDuke considers a strategy where he will buy properties and look to renovate and sell them within six months whilst nominating this as his main residence. He produces his 10 year masterplan to his tax advisor in which he estimates £1,000,000 of tax free profits involving the sale of over 20 properties.
His strategy is soon filed into the waste-paper bin when his tax advisor points out that this is abusing the PPR rule and will fail when challenged by the Inland Revenue.
Comments on this strategyAlthough there is nothing to stop Duke from implementing this strategy there is a very strong likelihood it will be challenged by the Inland Revenue and he will be classed as a ‘property trader’ and therefore will be liable to pay income tax on his profits.