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Proposed Changes To Private Residence Relief

Lee Sharpe warns that HMRC proposes to remove a vital component of the private residence relief capital gains tax rules, as a knee-jerk reaction to fears of rising house prices.

This article looks at HMRC’s proposal to remove the taxpayer’s power to nominate which is his or her main residence, in order to benefit from capital gains tax (CGT) private residence relief.

The oligarchs are coming!
While it may not exactly be news that a few ‘ultra-rich’ foreign businessmen can dictate government policy, it is arguably less common that they do so accidentally. There have been many stories in the press about how the house prices in prestigious areas of London are rising very quickly, to the point at which they are affordable to only a tiny percentage of wealthy people – epitomised by so-called oligarchs.

Some politicians are apparently concerned that this is causing the housing market to overheat, pushing up prices throughout London and beyond to unaffordable levels – at least for their voting constituents. HMRC and politicians have found common cause: HMRC’s concerns are that currently, individuals who are not UK tax-resident pay no CGT when they sell most UK assets, which is unfair to
UK-resident taxpayers.
But this is about to change and, unfortunately, it seems HMRC’s cure may well be worse than the disease.

Why should we care?
Of course, few of our readers are likely to be foreign billionaires: in truth, there simply aren’t that many around.

However, earlier last year, HMRC issued a consultation document ‘Implementing a CGT Charge on Non-Residents’.  It proposed to make individuals who are not tax-resident in the UK liable to CGT on their residential property/ies.  Again, so what? The problem, as with so much of what HMRC does, is in the detail.

HMRC realised that some overseas investors could nominate (say) their Knightsbridge apartment as their ‘only or main residence’ for CGT purposes, so that the specified property was effectively exempt from CGT anyway. So, their consultation proposed to do away with the power to nominate, altogether, from April 2015.

Flipping outrageous!
The power to nominate which property is your main residence was introduced with CGT in 1965, and is (for now at least) in TCGA 1992, s 222(5). As reported in Hansard at the time, the measure was to afford those taxpayers with more than one residence the choice of which should count as their CGT-exempt main residence for a particular period. 

HMRC wants to revoke the power to nominate and rely instead on a simple test – probably the one currently used when a nomination has not been exercised, which is to consider which is most used as the main residence.

The power to nominate a main residence also allowed canny property investors to ‘flip’ homes in a rising market, by combining a main residence nomination with the rule that exempts the final period of ownership which, up until recently, said that if a property was your main residence at any time, then the last three years of ownership prior to sale would be exempt, even if you didn’t live there:

Example: Main residence nomination
Three years ago, Ed bought a London apartment to live in, for £200,000; it is now worth £250,000. An opportunity to buy another apartment comes up, and he takes out a mortgage to buy it for £250,000, confident that both will continue to grow significantly in value, within the next couple of years.
Ed nominates the second property as his main residence. He quickly ‘flips’ the nomination back to the first apartment, so he has up to three years (but see below) to sell the second (or indeed the first) apartment, entirely free of CGT – however large the return – because of the ‘final period of ownership exemption’.
He sells the second flat 15 months later, for £280,000, pocketing a £30,000 gain, with no CGT. Had he sold the first property, there would have been a brief non-exempt period during which the second property was nominated, but this should be covered by the final period exemption if sold quickly, or Ed’s annual CGT exemption if sold later on.

However, it’s not as simple as it looks:

Ed has to live in the second apartment so that it can be considered a residence – it is a ‘qualitative’ test: what is the quality of the occupation? Transient occupation is insufficient.

HMRC has already reduced the ‘final period of ownership’ from three years to just 18 months, for most sales after 5 April 2014, so Ed has just a year and a half to sell either property, CGT-free. This surely deters most speculative investments, even in a market rising as quickly as in London.

There are already anti-avoidance provisions to block the exemption from purely speculative investments (TCGA 1992 s 224(3)).

Given the above conditions, it seems unlikely that many properties owned by non-resident investors would be eligible for main residence nomination in the first place. I have looked after overseas investors in UK property in the past, but they needed to let their properties from the outset in order to make it worthwhile – main residence exemption was not on the cards. The reduction of the ‘final period of ownership exemption’ to just 18 months likewise severely restricts the possibility of significant overlap between properties.

Do taxpayers really need the power to nominate?
Briefly, yes: the government of 1965 foresaw that taxpayers would sometimes have more than one residence – for instance, if job requirements took them to a new city (or country) – and were keen to promote, rather than inhibit, home ownership and mobility. According to HMRC, even a rented property, or one provided by an employer, can constitute an eligible residence. If an employee were seconded to a post in Europe for two years, then he or she might have a significant taxable gain on the UK family home when the time came to sell, thanks to these new proposals.  It seems quite unfair that people might have to sell a treasured family home, rather than risk a hefty CGT bill down the line.

Does HMRC realise the consequences?
In its consultation, HMRC asked, ‘Are there any particular circumstances where changing the nomination rules might lead to unintended consequences?’ It seems incredible that HMRC hadn’t considered why the nomination was legislated in the first place – discussion in the consultation was notable by its absence.

In fact, HMRC has been asked several times about the extent of the mischief of ‘flipping’ homes, and has repeatedly swerved the issue, as can be seen in Parliamentary questions noted in Hansard – most recently 6 March 2012, where David Gauke advised, ”No such assessment has been made as it is not possible to distinguish between the cost of private residence relief attributable to nominations of main residences for avoidance and non-avoidance purposes.“ And yet here we are, a couple of years later, abolishing the election!

Practical Tip:
What should we do? Regular readers will know that HMRC has ‘form’ in fudging consultations – such as the renewals basis for ‘unfurnished’ lettings – and property investors in particular should be slow to forgive. Although some bodies have published concern about these proposals, they have been overshadowed by other issues, such as HMRC’s attempts to wrest money directly from people’s bank accounts, so these proposals may not get the attention they deserve.

The government is, however, generally wary of introducing retrospective legislation, so a nomination made before April 2015 may well be protected – homeowners and investors should ensure they review their circumstances comfortably before that deadline, to see if a nomination is beneficial.

This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.