Replies to Queries - 2 - Principal private residence relief

Seven years ago, a builder client built himself a second house within the garden (which is less than one acre) of his existing principal residence. He subsequently moved into the new house which then became his principal residence. It was his intention at the time to renovate the original house in his retirement. However, the increase in value of the property has prompted him to bring forward the renovation plans and to sell the original house as soon as possible. Since moving out, it has remained unoccupied.

Our question is, is the unusually long period from moving out of the property to selling it, seven years, likely to prejudice his claim for principal private residence relief?

(Query T16,061) - Dunston.

There are a number of issues here. Firstly, 'Dunston' does not say if an election was made at all, or within the time limit of two years, for one of the houses (presumably the new one) to be the principal private residence. I suspect that no election was made. If this is the case, the Revenue has the power to decide which is to be treated as the principal private residence and my view is that, given the circumstances, they would select the new house for at least the last five years.

The first house was the principal private residence for the period from acquisition until at least the removal to the new house. Therefore the proportion of the overall gain attributable to that period may be exempt. In addition one would expect the last three years of ownership to be exempt, as the house was the principal private residence for part of the period of ownership.

However, section 224(3), Taxation of Chargeable Gains Act 1992 provides that section 223 (the principal private residence exemption) 'shall not apply in relation to a gain so far as attributable to any expenditure which was incurred after the beginning of the period of ownership and was incurred wholly or partly for the purpose of realising a gain from the disposal'. Therefore it seems to me that the gain would have to be analysed into four parts:

Gains (1) and (2) would be exempt; gains (3) and (4) would be chargeable to capital gains tax, to the extent they exceeded the annual exemption and any capital losses in the year or brought forward.

These comments have so far assumed that a trading element is not involved. However, the client is a builder, and it is likely that the Revenue might wish to claim that the original house had been taken into trading stock, or at least that the work done on it was done in a trading capacity. It will be necessary to look at how the work done on the house has been accounted for and paid for. If the work was carried out by the client's business, were invoices raised in the ordinary way, were materials paid by the business and invoiced out, or paid privately or not separately accounted for at all? These are all questions which must be answered before tax returns are completed, rather than when an investigation has been opened.

If the renovation and sale of the house is a trading transaction, or an adventure in the nature of a trade, capital gains tax applies to the gain up to the date of appropriation of the house to trading stock under section 161(1), Taxation of Chargeable Gains Act 1992 and income tax at basic and higher rates will be payable on the gain realised on sale. - Clube.

There are three separate problems here. The first is whether, and, if so, when section 222(1)(a), Taxation of Chargeable Gains Act 1992 ceased to apply to the first house.

Presumably the builder does not intend to sell the second house but, if he does, the fact that its site was originally within section 222(1)(b) does not mean that, once the first house has been sold, relief up to the date of moving house might not be lost. Varty v Lines [1976] STC 508, although arguably not conclusive, suggests that this will be the case. This is because the first house ceased to qualify under section 222(1)(a) when the builder moved into the second house (see Williams v Merrylees [1987] STC 445).

If nothing was done by way of pre-sale renovation, the position would be that the gain would be time apportioned, with the period during which the first house was the main residence and the last three years of ownership forming the basis of the exempt proportion (see section 223(1), Taxation of Chargeable Gains Act 1992).

Secondly, could this position be impaired by his carrying out renovations?

The scale of these is not indicated, and could range from carrying out arrears of maintenance to modernisation. So far as capital gains tax is concerned, the 'last three years' element of the exempt proportion would be reduced under limb 2 of section 224(3), Taxation of Chargeable Gains Act 1992.

Thirdly, what is the effect of the owner being a builder by trade?

Whilst the quasi-trading income tax head of charge could not apply, because of the provisions of section 776(9), Taxes Act 1988, consideration needs to be given to whether choosing to carry out works on the property before sale results in the first house being appropriated as trading stock.

If this was the case, then the act of appropriation would accelerate the occasion of the capital gains tax disposal, which would take place at market value (see section 161(1), Taxation of Chargeable Gains Act 1992). Because a sale is deemed to have taken place, the last three years for the purposes of section 223(1) would be calculated up to that date. The bulk of the value of the property would thereby be exempted from tax.

That said, the extensive case law on this subject would make it difficult for the Revenue to formulate a watertight case. It is therefore extremely unlikely that the Inspector would put forward such a contention, not least since the end result could be little different from that which would result from the application of section 224(3).

The fact that it is necessary to pose the second and third questions suggests, however, that pre-sale 'renovation' will create unnecessary tax problems. - Venta Belgarum.

Extract from reply by 'Lacuna':

On the face of it, relief will be due for the period during which the original property was the builder's only or main residence plus the last three years of ownership (section 223(1), Taxation of Chargeable Gains Act 1992). So the numerator of the fraction to establish the chargeable proportion of the gain arising will at present be four and the denominator will be the total period of ownership in years (or the period from 31 March 1982, if shorter).

If the chargeable gain arising on that basis would be substantial, but the value of the property is within the inheritance tax nil rate band of £250,000, the builder might consider settling the property on discretionary trusts for a class of beneficiaries which includes himself and other family members and then holding over the capital gain under section 260, Taxation of Chargeable Gains Act 1992.

The trustees could subsequently appoint an interest in possession to a beneficiary who would occupy the property as his or her only or main residence. On a subsequent sale by the trustees, the whole gain should be exempt under section 225, Taxation of Chargeable Gains Act 1992. This should then leave no gain to be attributed to the settlor under ibid., section 77.

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