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Business Tax  •  Personal tax  •  Property  •  Taxation

Understand tax efficient flips for second homes

By RJP LLP on 4 November, 2010

The tax bloggers at RJP's latest article explains 'flipping' - an important tax planning strategy for property owners.

’Flipping’’ a property became widely known as a property tax planning tactic when the MPs’ expenses scandal was in full swing.  In addition to claiming for all sorts of expenses, it was discovered that MPs were avoiding capital gains tax on second homes by alternating their living arrangements between properties owned, in some cases spending just one week a year in any one property.
Despite the adverse publicity, ’’flipping’’ residential properties was, and remains, legitimate tax planning which can help reduce capital gains tax (CGT) liabilities when property is sold.
How ‘’flipping’’ works
Normally when you sell your home, no CGT is payable on any gains you make.   If you sell a second property however, CGT will be payable (at the rate of 28% if you are a higher rate taxpayer).  Where a property has been your principal private residence (PPR) at any time during its ownership, the last three years of ownership are exempt from CGT based on current rules. This applies irrespective of whether the property concerned was your PPR at any time during those last three years, and irrespective of how long the period of time was during which the property was actually your PPR.
The question of whether a property is actually your PPR for a period of time will be a question of fact, unless you have made an election for it to be treated as such.

You are able to make an election for a property to be treated as your PPR if:
1. You make that election within 2 years of acquiring or disposing of any property (not necessarily the property for which you are making the election); and
2. The property for which the election is made is available for your use; and
3. You actually spend time there.
Once you have made an election within the time limit, you can vary that election at any stage. It is therefore useful to make an election within the 2 year time limit when you acquire any property, since the fact of having made the election, for whichever property, will enable you to vary it at any stage, without time limit.
You may for example have a holiday home where you spend part of the school summer holiday. You are able to elect for this property to be treated as your PPR for that period and then vary the election back to your usual PPR at the end of the holiday. The effect of this will be that you will have secured a PPR exemption on that property, not only for the period of the summer holiday, but also for the last 3 years of ownership of that property. In exchange, you will have ‘lost’ the PPR exemption on your usual home only for the period of the summer holiday, and not for the additional 3 year period.

If you do not make a PPR election, then the burden of proof that a property was your PPR as a matter of fact falls on you as the taxpayer.   This can be shown for example by producing utility bills or letters addressed to you at the property; the fact of having paid council tax; electoral role evidence; removal costs in moving furniture to the property and even by producing photographs  of yourself at the property at significant times and being active within the local community.

The recent case involving a New Malden resident and HMRC highlighted that to be successful at ‘’flipping’’, the strategy needs to be carefully thought through and if you are relying on fact, rather than an election, the burden of proof may prove onerous.  The individual in question had purchased a flat as a rental investment whilst living with his girlfriend in a shared property.  The couple separated for a period of time during which he moved into the rental property for a short period before a reconciliation took place which resulted in him returning to their joint home.  Some years later when he sold the rental property, he found he was ineligible for CGT relief on the final 3 years of ownership on the basis that it was his primary residence.  This was because he could not prove his case – he had not contacted HMRC or the local authorities with a change of address or had post redirected.  HMRC said they could find no reliable evidence that he was living at the flat, and they rejected his claim.

As long as an election is made, and provided sufficient proof of residence exists, whether the second home has also been rented out or used as a holiday home, it is still possible to benefit from principal residence tax breaks.
Finally, a further reason to secure PPR treatment wherever possible - there is an additional relief available for a property which has been your PPR at any stage and has also been rented out. This can result in additional gains of up to £40,000 per individual being exempt from CGT.

Seek advice when buying additional property to ensure the most beneficial tax treatment will apply when the time comes to sell.

To find out more, contact Lesley Stalker – las@rjp.co.uk

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