Basic Capital Gains Tax (CGT) rules state that the gain made on the disposal of a property is exempt from tax if the property is (or has at any time in the period of ownership been) the owners ‘only or main residence’ (deemed ‘Principal Private Residence’ - PPR). The property does not need to be the PPR at the date of sale, but if it has been for part of the period of ownership then the rules allow for the last three years ownership to be exempt as well as the period of actual residence.
Many owners of second homes or buy to let properties can also take advantage of this ‘three year rule’ to reduce the tax bill on the sale of their properties by the simple means of a signature on a piece of paper (i.e. an election), a practice known as ‘flipping’.
The way it works is that the tax law allows the owner of more than one property to elect which residence is to be treated as the PPR; this then enables the last three years of ownership to be tax-free. The property does not need to be the owners’ main residence in practice, although the owner must have actually lived in the property at some time but there is no time limit for this. The nominated property can be situated in the UK or be abroad.
Having made the initial election, it can then be varied (‘flipped’) as many times as required by giving a further notice to HMRC. There is no prescribed form or wording for the election but the rules state that it must be made within two years of acquiring a second (or subsequent) residence unless there is a delay in occupation, in which case the date of moving into the residence is the trigger event.
‘Flipping’ in Practice
· An election should be made as soon as possible following the purchase of a second property. Then, having made the election, the situation can be reviewed at any time up to the two-year anniversary date thereby keeping all options open. Alterations to the election, once made, can be made retrospectively.
· Having made an initial election, there is no limit to the number of times that the address of the property declared on the election can be changed. The address named is deemed the main PPR for the period of the election.
· There is no set minimum period of occupation to enable PPR residence to be established. Technically the election could be written to be in force for just one day but the relevant section of HMRC’s manual on the subject does state: ‘the test of residence is one of quality rather than quantity: the dwelling house must have become the owner’s home’ and although the manual goes further and states that ‘Every case must be decided upon its own particular facts’ it is recommended that basic methods to prove residency should be used. This could involve notifying regular correspondents (including HMRC) of the change of address, ensuring that the correct name is shown on the voting register and that full rates are paid.
· Practically the sale of a property takes at least two to three months but many sellers would have made the decision to sell some weeks before that so to take advantage of this tax planning exercise the election should be made citing the property to be sold once the actual decision to sell has been made. Then when the sale is completed the election is 'flipped' back to the main home. That main home loses the PPR relief but only for the period that it takes to actually sell the second property and this is likely to be insignificant in a long period of ownership.
Which Property Should Be ‘Flipped’?
Generally tax-wise PPR elections are beneficial but may not be so in a falling market when a loss could be made. Such losses can be carried forward and used against subsequent property gains or offset against other gains made in the tax year. An election on such a property will mean that the loss is reduced as the last three years of ownership will be deemed exempt.
Obviously, if there is more than one property to sell the election needs to be on the property that stands to make the most gain. Other factors may be relevant – for example, if the property is rented the rental agreement may not be able to be broken before the two-year cut off date or the amounts invested in improving the property will reduce the eventual gain to below the annual exempt amount without the need of the election.
What Happens if No Election is Made?
If no election is made, then on sale HMRC will make its own determination. There are no set rules or conditions to assist HMRC in making the decision, however time spent in a property is apparently not to be the sole deciding factor, the test being ‘one of quality rather than quantity’ (see ‘Flipping’ in Practice’).
What Happens if the Election Date is Missed?
Should the two-year time limit be missed altogether, there needs to be a ‘trigger’ event which will change what is termed the ‘combination of residences’ and re-set the election date.
Examples of ‘events’ include:
· Getting married
· Renting out one of the properties for a short period of time. When that letting comes to an end the owner will need to move back into the property as the PPR for a period and it is then that an election can be made, as the ‘combination of residences’ will have changed.
· An owner becoming a tenant of one of the properties.
· Selling half the house to a joint owner.
· Transferring the main residence to the trustees of a settlement under which the owner has a beneficial interest, with the proviso that the trustees allow the owner to remain in the residence. This action should not be undertaken without professional advice as there are other tax implications to be aware of.
· A late election may be allowed in the situation where an individual owns more than one residence and his interest in each of them (or in each of them except one) has a negligible capital value on the open market (for example a weekly rented flat) and the individual was unaware that such an election was possible (HMRC Concession D21).
‘Serial’ Property Sellers
If the election is ‘flipped’ in quick succession, HMRC could start an investigation trying to prove that the only reason for making each election is to avoid paying tax.
Furthermore, such ‘serial sellers’ run the risk of being classed as property ‘traders’ and be taxed under income tax rather than CGT rules. The HMRC and Land Registry computer systems are linked such that properties sold within short timescales can be identified and tax return details checked.
· An election should be made immediately on the purchase of the second property – this ensures that the two-year time limit is not missed and provides flexibility as the election can then be subsequently altered if required.
· If buying and selling in quick succession, compile evidence to show intention to live in the property rather than purchasing it with an intention of making a profit.
By Jennifer Adams