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Home Improvement or Property Development? CGT and your Main Residence

Home Improvement or Property Development? CGT and your Main Residence
Even as house prices decline, the daytime TV channels are still full of programmes about buying and selling property, and about home improvements. Most homeowners think in terms of selling their home at a profit one day in the future, and the purveyors of conservatories, swimming pools and double glazing advertise at least partly on the basis that if you spend money on their product you will get a better price for your house when the time comes to sell it.

 

When selling a large house, it is quite common for the estate agent to advise converting it into flats on the basis that this will realise a better price than selling the house as it stands.

 

There is a nasty piece of legislation lurking in the rules for the exemption from CGT for a capital gain made on the sale of your “only or main residence”. Section 224 (3) of the Taxation of Chargeable Gains Act 1992 denies the exemption for a main residence in two situations:

 

?  Where the residence was purchased “wholly or partly” for the purpose of realising a gain on its sale, or

?  Where money is spent on an existing residence “wholly or partly” for the purpose of realising a gain on its sale

 

At first glance, this means none of us are entitled to exemption from the gain we make when we sell our home - who can honestly say that he did not at least “partly” consider the future prospect of a sale when buying his home?

 

Fortunately, HMRC do not take such a hard line. They will normally only invoke this legislation in three circumstances:

 

Pseudo Property Development

If you buy a run-down property and actually live in it while you do it up, then sell it at a profit say nine months after you bought it, it is almost impossible for HMRC to argue that you are a property developer. As long as the property was genuinely your home while you did it up, then it was your main residence and it cannot be part of your trading stock at the same time. You may get away with this once, but if you make a habit of doing it, HMRC may well invoke section 224 (3) and charge you to CGT on the profit you have made.

 

“Enfranchisement”

This is the process whereby a leasehold tenant buys the freehold from his landlord so that he becomes the outright owner of the property. Clearly, a freehold interest is worth significantly more than a lease of, say, 30 years, so this is worth doing for the tenant. If, however, you then sell the property, HMRC may again say that you bought the freehold “wholly or partly” to increase the profit you made on the sale, and again deny you the main residence exemption.

 

Conversions and extensions

Spending money on converting your house into flats which you then sell, or on building an extension, may attract tax under section 224 (3). In the case of an extension, much will depend on the reasons for it (somewhere for granny to live, perhaps?) and how long it is between the work being done and the sale. In the case of conversion to flats, it is virtually impossible to argue that your motive was not to realise a gain if you immediately sell one or more of the flats.

 

Calculation of lost exemption

If you are caught by section 224 (3), then in a case where you have spent money on a property that was already your main residence, not all the gain loses its exemption. Only the gain attributable to the expenditure is taxable.

 

This is easiest to explain by way of an example:

 

Casey (some years after passing his Chartered Tax Adviser Exams) decides to move up the property ladder. His old house is valued at £300,000, but the estate agent explains that if he were to spend £50,000 on converting it into three flats, each would sell for £150,000. Casey takes the advice, and manages to sell the flats as predicted.

 

Not all the gain is exempt, and the computation goes like this:

 

 

Sale proceeds of three flats
  450,000
 
Market value before flat conversion
 (300,000)
 
Gain attributable to conversion
  150,000
 
Cost of conversion
  (50,000)
 
Gain charged to CGT
  100,000
 
CGT at 18% (after annual exempt amount)
   16,272

 

Notice that Casey is still better off as a result of the conversion work - this is an important point in all tax planning. Just because a project will attract some tax does not mean it should be abandoned.

 

James Bailey