This TAXguide written by Gillian Banks is an update of TAXguide 07/19 which was published in May 2019 and which updated, and superseded, chapter one from the 2012/13 TAXline Tax Planning book, a guide to principal private residence relief, written by Robert Maas. This latest version has been updated to include changes introduced in Finance Act 2020.

Overview

Capital gains tax (CGT) principal private residence relief (PPR) is one of those areas of the tax legislation where everyone thinks that they know the rules but, in reality there are so many nuances in them that it is easy to fall unwittingly into a tax trap. This TAXguide is the latest update to a TAXguide which was originally based upon chapter one from the 2012/13 TAXline Tax Planning book, a guide to principal private residence relief, written by Robert Maas. Since its publication there have been a number of additional tax cases, adding to the surprisingly high number that existed at that time, as well as some legislative changes.

The legislation

The starting point is s222(1), Taxation of Chargeable Gains Act (TCGA) 1992:

“This section applies to a gain accruing to an individual so far as attributable to the disposal of, or of an interest in –

a) 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, or

b) land, which he has for his own occupation and enjoyment with that residence as its garden or grounds up to the permitted area.”

The relief is extended by s225 to include certain residential property comprised within a settlement, as follows:

“a gain accruing to the trustees of a settlement on a disposal of settled property being an asset within section 222(1) where, during the period of ownership of the trustees, the dwelling house or part of the dwelling house mentioned in that subsection has been the only or main residence of a person “B” entitled to occupy it under the terms of the settlement.”

The first important point to note, therefore, is that the PPR applies only to individuals and settlements. It does not apply to a residential property gain made by a company, including a company owned by a settlement. Neither does it apply to a gain on residential property made by an overseas company that is apportioned to a UK shareholder under s13(3), TCGA 1992.

In cases where residential property is comprised in a settlement, it will be important to determine eligibility to the PPR. Clearly, the relief applies where the beneficiary is the life tenant. But what about a discretionary settlement? The High Court has held that the relief can apply (Sansom & Another v Peay 52 TC 1) albeit with the following word of warning:

“Nor do I intend to travel outside the facts of the particular case before me. In this case the beneficiaries … were in occupation pursuant to the exercise by the trustees of a power expressly conferred by the settlement to permit those beneficiaries to go into occupation and to continue in occupation until the permission was withdrawn … Therefore … the beneficiaries were persons who, in the events which happened, were entitled to occupy the house and did occupy it under the terms of the settlement.”

Accordingly, the relief applies where the occupation results from the exercise by the trustees of a power expressly conferred by the settlement. However, the judge in that case made it clear that the decision was based on the facts of that case. What if the facts were not the same as in that case? For example, there is no express power in the trust but the trustees simply permit occupation? Or where there is an express power but there is no evidence that the trustees actually exercised it?

What is a dwelling house?

The next question is what is a dwelling house or part of a dwelling house. ‘Dwelling house’ is an ordinary English word. It means a place where someone lives. However, the PPR is not for a dwelling house; it is for a dwelling house which is (or has been) the owner’s residence

In Lewis v Rook 64 TC 567, the Court of Appeal held that the term includes anything which is within the “curtilage of, and appurtenant to”, the main property so as to be part of the entity which, together with the main property, constituted the dwelling house occupied by the taxpayer as her main residence. This can apply even if a building within that test is a separate dwelling house, such as a housekeeper’s cottage. However, in Lady Rook’s case, the cottage was separated from the main house by a large garden, a fact which lead the court to the ‘inescapable conclusion’ that the cottage was not within the curtilage of, and appurtenant to, the main house, albeit that the two were both part of a large estate.

What is a residence?

Residence is a much more difficult concept. In Goodwin v Curtis 70 TC 478, the Court of Appeal relied on the definition of residence as set out by Viscount Cave in Levene v CIR 13 TC 486, namely a place: ‘where a man has his settled or usual abode’. At first glance, it seems odd that for the purposes of PPR the courts should rely on a definition of residence arrived at in the context of determining the country in which Mr Levene was tax resident. The reason is that Viscount Cave treated the word ‘reside’ as a ‘familiar English word’ and gave it its dictionary definition. In recent years HMRC seem to have looked more carefully at whether a property is a person’s residence, particularly where a person owns two or more properties, but also where the occupation has been short, or as part and parcel of a renovation project. A significant number of such cases have been taken to First-tier Tribunal (FTT) in recent years, generally following the decision in Goodwin v Curtis.

It is clear that two or more properties can simultaneously qualify as residences. Section 222(5), TCGA 1992 allows a taxpayer to elect which of two or more residences (not dwelling houses) is his or her main residence (more detail below), which implies that for a valid election to be made each must meet the test of being a residence.

The quality of occupation is a particularly important issue in the context of standard tax planning advice that where a person has more than one residence, they should elect each as the main residence for a short period of time so as to secure the nine bonus months (for disposals from 6 April 2020, reduced from three bonus years then to 18 months in recent years) at the end of the period of ownership.

So what does a taxpayer need to do to show quality of occupation? That is a question of fact, so the answer is case specific. Study of a few of the recent FTT cases mentioned above will be instructive. The property needs to look like a residence. Putting in a camp bed and a second-hand table and chairs for a few weeks and living on takeaways during the residence period is clearly insufficient. The property needs to be furnished at least to a normally expected living standard. And remember that, when it comes to facts, there are facts that occur and facts that can be proved, and it is the latter that is important, so take some photographs so that it can be proved that it was furnished to a reasonable standard. It actually needs to be used as a residence. HMRC is likely to ask to see utility bills. Are these in the name of the taxpayer, or his or her letting agent? Are they consistent with occupation? If a person occupies a property for three months as his or her residence, he or she is unlikely to have used only a small amount of gas or electricity during that period.

HMRC may also ask about council tax. They may challenge a property which is registered as the taxpayer’s second home.

Other things to consider are registration with HMRC and inclusion on the electoral roll. If you are claiming that a property has become a person’s residence, tell HMRC that he or she is now using that property as his or her main address. This is particularly important if a person is between residences, (ie, he or she has sold house A and intends to move into house B when he or she has renovated it but has bought house C to use as a stopgap in the interim). They will have to prove that house C was used as a residence, not as simply somewhere to sleep until house B became ready for occupation, and quite a lot of evidence will be needed to show this. Having told HMRC at the time that it was a residence, and having registered the address on the electoral roll will both support the contention that it was a residence. As tax agent, can you show that is the address to which you sent any postal correspondence to the client in that period?

Tribunal decisions

Although HMRC has won most of the cases that it has taken in recently years, this may well be because it only takes cases where the facts are strongly in its favour. Provided that you can distinguish your client’s case, do not be afraid to argue it as the Tribunal could take a different view of the facts. HMRC tends to look for written evidence and to discount oral evidence, but the Tribunals will put greater emphasis on such evidence (although normally expect some sort of documentary evidence to reinforce what they are told). Also, it is apparent from the cases that intention is very important (ie, the individual’s mind-set when they moved into the property). If you have to rely on oral evidence, try to get not only the client to give evidence but also someone else, such as a friend or neighbour, who can testify that the client was living in the property as his or her home.

Capital gains tax versus income tax

It should also not be overlooked that CGT is a sweep-up tax. Income tax takes priority over it. If something is chargeable to income tax, the CGT rules are irrelevant. The taxpayer does not have a choice which tax he or she pays. The reason for mentioning this is that there is a common misconception that everyone is entitled to own at least one property at a time and treat it as their main residence. If a person buys a property with the intention of, say, converting it into three flats and selling them on, that is by its nature a dealing or trading transaction. The fact that the taxpayer chooses to live in his or her trading stock while he or she carries out the development – or even buys it with a subsidiary intention of living in it meanwhile – cannot turn a trading transaction into something else. It is irrelevant that the taxpayer can show that he or she used the property as a residence in such circumstances. Charges under the transactions in UK land rules (see Pt 9A, ITA 2007) may also apply. 

The position may be different if the taxpayer always had an intention to live in one of the flats when the development was completed. In such a case the ultimate ‘profit’ on his or her own flat may well be a capital gain which can be eliminated by PPR, but that on the other two flats is still likely to be liable to income tax (see for example Iswera v Ceylon Commissioner of Inland Revenue [1965] 1 WLR 663). Indeed it is not even necessary to carry out development. If a person buys a series of properties with the intention of living in each for a short time and then selling and buying another, he or she may have difficulty in rebutting a contention of property dealing. 

In addition to the income tax rules set out above, the CGT PPR rules also contain a restriction (s 224(3), TCGA 1992) which denies the PPR if the acquisition of an interest in a dwelling house was made ‘wholly or partly for the purpose of realising a gain from the disposal of it’. 

The PPR election

S 222(5), TCGA 1992, allows a taxpayer who owns two or more residences at the same time to determine by notice to HMRC which is his or her main residence. The notice can only be given ‘so far as it is necessary’ to determine which is the main residence for any period, and must be given within two years from the beginning of that period. It was held in Griffin v Craig-Harvey 66 TC 396 that this means that the notice has to be given within two years of the acquisition of the second residence. Once a notice has been given, it can be varied at any time, with effect from up to two years prior to the variation notice. However, if the initial time limit is missed, no election can ever be made unless, at a later date, something happens to create a fresh necessity to determine which of two or more residences is the main residence.

HMRC regards a rented property as being a residence for the purpose of s222, TCGA 1992 even though no valuable interest in it is owned by the taxpayer (Capital Gains Manual, CG64470). Where a property is rented on a monthly tenancy, it is not clear that the right to occupy is an interest in land. Nevertheless that is HMRC’s published view. It accepts that a licence to occupy does not create an interest in land. The former ESC D21 which extended the time limit for a PPR election in these circumstances has now been put on a statutory basis (s24, FA 2020 inserting new sub-s5A into s222, TCGA 1992). With effect from 6 April 2020, PPR elections can be made without time limit where the interest in one of the properties is of no more than negligible market value.

Land

Section 222(1), TCGA 1992 gives two separate reliefs, one for the dwelling house and the second for “land which the taxpayer has for his own occupation and enjoyment with the residence as its garden or grounds up to the permitted area.” The permitted area is a half hectare (but inclusive of the site of the dwelling house). However, when the area required for the ‘reasonable enjoyment’ of the dwelling house, having regard to its size and character, exceeds a half hectare, that larger area becomes the permitted area. If the land exceeds the permitted area, the permitted area is carved out of the part that would be most suitable for occupation and enjoyment with the residence (ss222(2)– (4), TCGA 1992).

There are a number of points here. As mentioned above the half hectare limit includes the area of the house itself. However, it is probable that outbuildings are part of the house for this purpose (Lewis v Rook 64 TC 567).

The FTT case: W & H Ritchie v HMRC, [2017] UKFTT 449 (TC), looked at (amongst other interesting points) whether and to what extent grounds exceeding half a hectare (and their sheds) were required for the enjoyment of the house. There are a number of other cases dealing with a range of situations including, for example, what qualifies for relief where land is separated from the house and sales of part only of the grounds.

Land must be garden or grounds. HMRC says that a garden is an enclosed piece of ground devoted to the cultivation of flowers, fruit or vegetables (Capital Gains Manual, CG64360). It seems doubtful whether that is an apt description for very many suburban gardens. HMRC defines grounds as:

“Enclosed land surrounding or attached to a dwelling house or other building serving chiefly for ornament or recreation”. 

It accepts that paddocks and orchards are normally part of the grounds but only if there is no significant business use, but this is still subject to the “reasonably required” test. However, it also says that the land does not have to be exclusively used as garden or grounds, which appears to permit business use provided that there is also some personal use. Where the answer is not clear it is worth reviewing the case law to see if a similar situation has already been looked at by the courts.

Where the half hectare limit is exceeded, HMRC normally asks the District Valuer to determine how much, if any, extra land qualifies and which that land is. As HMRC regards it as a land valuation issue, it will normally be sensible for the taxpayer to appoint a surveyor to negotiate with the Valuation Office.

The relief

Section 223(1) says that where the land or property has been the taxpayer’s principal private residence throughout the whole period of ownership, the gain is not a chargeable gain. The property is treated as having been the principal residence throughout the last nine months of ownership (18 months for disposals before 6 April 2020), irrespective of the use to which it was actually put.

If s223(1) does not apply, s223(2) apportions the gain between periods of occupation and absence. For this purpose, certain absences are treated as periods of occupation: a period of absence not exceeding three years (or periods which together do not exceed three years), provided that there was both some earlier and later time during which it was actually the private residence (s223(3)(a), TCGA 1992). There are differing views on how this should be interpreted, but if there is a period of absence (which does not fall within s223(3)(b)–(d)) of, say, four years, HMRC regards the first three years as a qualifying period and the last year as a non-qualifying one (see the example in CG65066).

In addition to the s223(3)(a) period, any period of absence during which the individual (or his or her spouse or civil partner) worked in an office or employment the duties of which were performed outside the UK, and any period of absence (not exceeding four years) throughout which the individual (or his or her spouse or civil partner) was prevented from residing in the dwelling house because of the location of his or her place of work or of a condition reasonably imposed by his or her employer requiring him or her to reside elsewhere, can also be treated as a period during which the property was the taxpayer’s principal private residence. Again this is provided that there was a time both before and after the relevant period during which the property was the principal private residence or, if it was not reoccupied, this was because of the work need to reside elsewhere (s223(3)(b)–(d), (3B) TCGA 1992).

All of these additional periods of absence are subject to the proviso that throughout the period in question the taxpayer had no other residence or main residence eligible for relief under s223, TCGA 1992. 

It should be noted that s223(3)(b) (working abroad) applies only where the taxpayer is in employment; it does not apply to the self-employed. In contrast, s223(3)(c) (situation of UK place of work) does apply to the self-employed as well as to employees, although clearly the second leg (condition imposed by the employer) cannot apply to the self-employed.

The obligation to reoccupy the property means that it must be occupied as a residence; a token reoccupation is not sufficient (CG65050).

In addition to the s223(3) reliefs, there is a further relief for ‘job-related accommodation’. This is not considered further here. The relevant legislation is in s222(8)–(8D), TCGA 1992.

Non-resident CGT disposals

Non-UK residents have been taxable on gains on UK situated residential property since 6 April 2015 (“NRCGT”). To prevent avoidance of this by non-UK residents simply electing for their UK residence to be their main residence, additional requirements have to be met for a property to qualify as a residence. Each tax year, or partial year, is considered and a dwelling will not qualify as a residence if i) neither the individual, P, nor P’s spouse or civil partner was resident (as defined in s222B) in the same territory as the dwelling; and ii) the day count test is not met. P meets the day count test if, during the year, P and/or P’s spouse or civil partner spend at least 90 days (pro-rated for partial years of ownership) in that, or another, dwelling house of theirs in the same territory. They cannot count the same day twice. A day counts if P is present at the house at the end of the day; or is present there for some period during the day, and the next day has stayed overnight at the house. This is to avoid Cinderella’s problem with parties!

An election (which needs to be made by both spouses/civil partners if relevant) can be made within the usual two-year limit, or on their CGT return. Elections can be varied, but not after a property has been sold.

The interaction of these new rules is complex and must be considered carefully when looking at particular situations. For example, the nine-month final period can be taken into account where a dwelling has ever been a residence, perhaps where a previously UK resident individual has retired abroad. But the absence reliefs mentioned above, that only apply where there is a period of actual residence in the property both before and after the absence, will not be available where the earlier period of residence ceased before 6 April 2015. This is the default position, the date on which the property will be rebased for NRCGT purposes. It is also possible to elect not to rebase as at 6 April 2015 and either (i) apportion any gain on a straight-line time apportionment between the pre and post 6 April 2015 periods, or (ii) use the actual base cost with no time apportionment instead. This latter election is only likely to be beneficial if there are losses. The elections need to be made on the CGT return.

Remember also, that a day in a residence in the UK is also likely to count as a day in the UK for the statutory residence test.

It is worth noting that although these rules were designed primarily to deal with non-residents owning a UK dwelling, the ability to elect for a dwelling to be a main residence is similarly restricted for UK residents who own dwellings overseas.

Period of ownership

When does the period of ownership for the purpose of s223, TCGA 1992 start and finish? Subject to the proviso that the period does not include any period before 31 March 1982 (when there was a rebasing) this would seem to be a straightforward question, but it was one that has been considered in detail in the recent case Higgins v R&C Commrs [2019] EWCA Civ 1860. Mr Higgins bought an apartment off plan in a hotel that was being redeveloped. Initially the apartment did not exist. It was merely a space in a tower. The developer suffered some commercial difficulties that resulted in a delay of over five years between the payment of an initial deposit (in 2004) and the final completion of the purchase in early 2010. Contracts were formally exchanged in 2006. Mr Higgins moved in shortly after completion and lived in the apartment for two years, vacating it when he sold it in 2012.

Mr Higgins contended that the words “period of ownership” should be given their ordinary meaning and thus run from the date of completion of the purchase. The FTT agreed, but this decision was overturned by the Upper Tribunal (UT), which said that s28, TCGA 1992 should apply, so that the period of ownership started in 2006 on exchange of contracts (which meant a smaller fraction of the gain was exempted). Notwithstanding the apartment did not exist for some time after that date, Mr Higgins did own an asset after that date, they said. They noted that a gain on the asset may accrue throughout the period of ownership, not just the period it is a dwelling that can be occupied by the owner. However, the UT decision was overturned by the Court of Appeal in a unanimous judgment that has not been appealed. A more detailed review of the case is available in my TAXline article.

This area is one that the Office of Tax Simplification has mentioned as requiring some consideration as part of its CGT review launched in July 2020, but unless there is further change, the dates of completion of purchase and sale will be determine the period of ownership for PPR purposes.

Where an individual acquires an interest in a dwelling house from 6 April 2020 from their spouse or civil partner, whether during lifetime or on death, the recipient will be treated as having owned the property from the date it was acquired by the transferor. For transfers prior to that date the property had to be their only or main residence at the time of transfer for this to apply. If this deemed extension applies, any part of the period during which the transferor occupied the residence as their only or main residence will be treated as similar occupation by the transferee.

Let property

For disposals before 6 April 2020 s223(4), TCGA 1992 granted additional relief:

“where a gain to which s222 applies accrues to any individual and the dwelling house in question or, any part of it, is, or has at any time in his period of ownership been, wholly or partly let by him as residential accommodation.”

The extra relief where the property was let for part of the period of ownership (which could be before, during or after the period of personal occupation) was stated as the lesser of:

• a) £40,000;
• b) the amount of the gain covered by PPR on the property; and
• c) the part of the chargeable gain that arises by reason of the letting.

There are some examples of the calculations in Self Assessment Helpsheet HS283 and further examples in the Capital Gains Manual at CG64737.

This subsection was replaced with s223B, TCGA 1992 for disposals on or after 6 April 2020. The dwelling must now have been the only or main residence of the individual during the let periods (ie, both landlord and tenant living in the same property). This change will remove this relief for cases where the whole dwelling is let, (ie, most individuals for whom it previously applied), but the relief is retained for cases where part of a dwelling, for example a “granny flat”, is let and the owner lives in another part of the property. Here the lettings relief will be calculated by reference to the lesser of the three calculations cited above.  

Where rooms have been let to lodgers, for example under the rent-a-room scheme, in most cases the lodger/tenant will not have occupied any part of the property to the exclusion of the owner, so relief would not have been restricted anyway.  

Losses

The PPR is mandatory; it does not have to be claimed. HMRC says that the effect of this is to restrict relief for a loss on the property as s16(2), TCGA 1992 provides that:

“Except as otherwise expressly provided all the provisions of the Act which distinguish gains which are chargeable gains from those which are not, or which make part of a gain a chargeable gain and part not, shall apply also to distinguish losses which are allowable losses from those which are not, and to make part of a loss an allowable loss, and part not.”

However, it accepts (see CG65080) that this does not apply to the extra lettings relief under s223B(1), as the subsection restricts ‘the part of the gain’ which arises, so cannot apply if there is no gain. The calculation of the loss and the restriction of the loss is the same as that for a gain and the restriction of the gain. Where the dwelling of a beneficiary owned by a settlement is disposed of PPR for the property is not automatic; it has to be claimed. A claim cannot be made if there is no gain, so if a property is disposed of at a loss, the loss will not be restricted.

Restrictions

The relief is restricted where part of the dwelling house is used exclusively for the purpose of a trade or business or a profession or vocation (but not an office or employment). HMRC says (CG64663):

“The exclusive use test is a stringent one and you should not usually seek any restriction to relief for a room which has some measure of regular residential use. But occasional and very minor residential use should be disregarded.”

HMRC also says:

“Any private use fraction agreed for the purposes of computing profits chargeable as income provides a poor guide to the apportionment required by s224(1), TCGA 1992.”

If s224 does apply, it apportions the gross gain and allows only the non-trade apportionment to come within the relief at s223, TCGA 1992.

The relief also does not apply to a gain so far as it is attributable to any expenditure which was incurred wholly or partly for the purpose of realising a gain from the disposal (s224(3), TCGA 1992 – see comments above). This is very widely drawn and could be thought to apply to anyone who buys or improves their home harbouring the hope that it will appreciate in value. In practice, HMRC accepts that it should not apply unless the primary purpose was an early disposal at a profit. HMRC also says that:

“In determining whether there has been any expenditure which could trigger a restriction to relief, you should ignore the costs of obtaining planning permission or the release of any restrictive covenant” (CG65243).

It highlights the two areas where the restriction is likely to occur as the acquisition by a leaseholder of a superior interest in the property and the conversion of a house into flats (CG65265). Where the restriction applies, the taxable element is the difference between the value without the expenditure and the value after incurring it. Before the expenditure is incurred, there may well be a ‘hope value’ in the property. Such value would not be attributable to the expenditure as it will already have existed. In particular it should be noted that the restriction is triggered by expenditure, and the timing of it (eg, whether shortly before putting the property on the market or some years previously) may be important. Also, to the extent that an increase in value is attributable to the owner’s own labour, the restriction should not apply.

Other matters

HMRC says that the receipt of a forfeited deposit does not qualify for PPR (Capital Gains Manual, CG64609) because it is not the disposal of an interest in a residence. It could be argued that such a receipt could be a capital sum derived from the property, and so deemed to be a part disposal.

Care needs to be taken where a principal residence passes on death but continues to be occupied by a legatee under the terms of the deceased’s will. The personal representatives can claim PPR if the property was occupied as the only or main residence of one or more individuals both immediately before and after the death and those individuals are entitled as legatees to (or to an interest in possession in) some part of the net proceeds of the disposal (s225A(2)(3), TCGA 1992), and together at least 75% of the net proceeds. The relief will be lost if the estate is left on discretionary trusts, although post death variation under s62(6), TCGA 1992, can be used to correct the position. Alternatively, the property can be distributed in-specie to the beneficiary. That will not trigger a disposal by the personal representatives as the beneficiary is then deemed to have acquired the property at the date of death at its then market value (s62(4), TCGA 1992).

Special rules apply to disposals connected with a divorce (s225B, TCGA 1992), sales under certain agreements with an employer (s225C, TCGA 1992), adult placement carers (s225D, TCGA 1992), disposals by disabled persons in care homes (s225E, TCGA 1992) and houses occupied by a dependent relative since before 6 April 1988 (s226, TCGA 1992). As these are not of general application, space precludes their being considered here.

However, mention should be made of s226A, TCGA 1992. This denies PPR completely where there was an earlier gift on which the gain was held over under s260, TCGA 1992 (gift relief where gift is within the scope of IHT). There is a limited exception where the gift was prior to 10 December 2003. In such circumstances, the exemption is preserved in respect of the pre 10 December 2003 period of ownership but cannot apply in relation to occupation after that date.

60-day reporting

A person disposing of UK residential property may need to report the disposal to HMRC within 60 days. This is considered in TAXguide 15/20: Capital gains tax UK property disposal reporting.

About the author

Gillian Banks, BSc, FCA
Gillian Banks is private client tax director at PricewaterhouseCoopers LLP. 
She is a member of the Private Client Sub-committee of the ICAEW ’s Tax Faculty.