Tax and Second Homes

Most people are aware that they don’t have to pay Capital Gains Tax (CGT) if they sell their home for more than they paid for it. This “profit” is essentially tax free.

Like any other general rule, however, it can be a bit more complicated than that – this is particularly the case if you have two homes. Does the exemption apply to both properties or is there some way of choosing between the two of them? Unfortunately, it is the latter.

The exemption is for your main residence and you can have only one main residence at a time. If you do have two homes, it will usually (but not always) be fairly obvious which one is your main residence. Nevertheless, you also have the right to choose which one to treat as your main residence for CGT purposes provided you do so within two years of acquiring the second property. This right is a very valuable tax planning tool as it enables you to choose whichever you like – even if you choose the property which is not actually your main residence in fact.

If you fail to make an election, then the issue is decided on the facts alone. It will normally be a good idea to make an election as you do have the right to alter the choice for later periods if you wish – even if the initial two years have passed. This switching of properties was highlighted in the MPs’ expenses scandal a couple of years ago when it was called “flipping”.

One thing that has to be clear, however, is that a property can only be your main residence if it is a residence of yours at all. That may seem obvious but it does need to be said. If you have a property that you are renting out then it cannot be a residence of yours at the same time – and don’t forget that the taxman will want Income Tax on the rents too. Even spending the occasional night in a house will not be enough; to be residence, the courts have decreed that some degree of permanence in the occupation is needed.

Nevertheless, it will perhaps be obvious that for any given property there might be periods when it is treated as a main residence and periods when it is not. In circumstances like that you are also allowed to treat the last three years of ownership as an exempt period (whether it was the main residence or not) and the capital gain is then apportioned between the exempt and non-exempt periods by reference to the total time in each. Limited further deductions can also then be made if the property has been rented.

The message here is that CGT on second homes (and rented properties) can be a significant problem but that in many cases it is possible to reduce the tax liability to manageable proportions or even avoid it altogether. To do this most effectively, however, it is best to put planning in place as soon as possible.

Bob Wheatcroft
Partner and Head of Tax

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