Residential properties and tax liability

From principal private residence relief to inheritance tax and capital gains tax, home owners need to keep up to speed with tax liability.

Chris Thorpe, LLB ATT CTA TEP, Techincal Officer, CIOT

One of the most valuable capital gains tax (CGT) reliefs is principal private residence relief (PPR), potentially available on the sale of a main residence. The Office of Tax Simplification’s (OTS) report of May 2021 pointed out that between 1.5m to 2m homeowners benefit annually from the relief, which cost the Exchequer £25bn in 2019–20.

Provided that the property has been lived in for the entire time of ownership as a sole or main residence, then the entire gain on sale is completely tax-free – including the garden or grounds (anything over 0.5 hectares needs to be required for the reasonable enjoyment).

A residence is somewhere where there is a ‘degree of permanence, continuity and the expectation of continuity’ (per Goodwin v Curtis (HMIT) (1998] BTC 176), ie, it must be a genuine residence, as opposed to a temporary home or an occasional holiday home.

Certain periods of absence can be deemed as in occupation, and the final nine months’ ownership will always be deemed as such for a genuine residence.

If the relief does not apply, then CGT will apply on the disposal of the house at a higher rate than the usual 10%/20% – rather 18%/28%.

A recent change to PPR concerns situations where the joint owners are getting divorced. When the home is disposed of to a third party on or after 6 April 2023, it is possible for the spouse or civil partner who ceases to live in the home to claim to be treated as if they had continued living there until the date of disposal for PPR purposes so that the relief is not restricted if there is a delay of more than nine months before the sale.

PPR can also be retained where deferred sale orders are in place.

Inheritance tax (IHT)

Residential properties have traditionally been a big problem for inheritance tax (IHT) planning; they constitute the most valuable asset in most people’s estates and given the increase in house prices over the last 20 years, this is more pronounced today.

The nil rate band (NRB) is £325,000 and it has been at this level since 2009, which has been left behind by house price inflation since then.

For people’s main residence, they will likely need to continue living there for the rest of their lives, so they cannot give it away and remove it from their estate as they are reserving a benefit – unless they pay a market rent to the new owners.

To address this, from 2017, an additional NRB became available for individuals’ death estates. This residential nil rate band (RNRB) started out at £100,000 in 2017 and gradually increased to the current £175,000 with effect from 2020.

Like the main NRB, an unused proportion of the RNRB can be transferred to a surviving spouse or civil partner and is set against the total estate; but unlike the main NRB, this RNRB is only available upon death.

It also only applies if a residence is bequeathed to a direct descendent, ie, children, grandchildren – it cannot go diagonally to cousins, aunts/uncles, etc. It can go to descendants via interest in possession trusts – but not discretionary trusts, as there is insufficient nexus between the trust assets and potential beneficiaries.

Another feature of the RNRB is that once the value of one’s net estate exceeds £2m immediately before death, for every £2 in excess the RNRB is reduced by £1.

Because this £2m threshold is measured against the value of the net estate, any business property relief (BPR) or agricultural property relief (APR) is not factored into the calculations – so someone whose estate largely consists of a trading business and/or a farm, would not be immune from this restriction.

A farmhouse, ie, a house occupied by someone occupying surrounding land for agricultural purposes, and one ‘character appropriate’, will qualify for APR.

The agricultural value of the house will be reduced by APR, for both lifetime gifts and on death. Being a farmhouse means that TCGA 1992, s165 holdover relief is available on gifts of the property, so CGT would not be an issue as it usually is with residential properties. The same applies to farm workers’ cottages. BPR may be available if a residential property is an integral part of a trading business, eg, housing employees.

Costs of purchasing a property

Purchasing a residential property will incur stamp duty land tax (SDLT) in England and Northern Ireland, land and buildings transaction tax (LBTT) in Scotland, and land transaction tax (LTT) in Wales.

The rates for purely residential property are higher than those for mixed properties (ie, those with a commercial element), and the purchase of an additional residential property (which is not a replacement of the main residence) incurs a surcharge: 3% for SDLT, 4% for LTT (albeit not on the same taxable bands) and 6% for LBTT. Non-UK residents also pay an additional 2% SDLT charge.

Corporate ownership

Limited companies buying a residential property may have to pay a flat-rate SDLT charge of 15% on the entire purchase price of residential properties costing above £500,000 if the property is not used in a property rental business or for certain other approved business purposes.

If the 15% rate does not apply due to one of the reliefs, the company will still have to pay the surcharge for additional residential properties (every residential property a company buys is treated as an ‘additional’ property for this purpose).

For those same properties, companies would have to pay an annual charge – the annual tax on enveloped dwellings (ATED); the same reliefs for use in a business, etc, are in place for ATED, so these charges are largely reserved for properties for the private use of shareholders/directors.

Income tax benefit-in-kind charges would also likely arise in such scenarios. The holding of a residential property through a limited company is therefore generally only advisable when the property has a business purpose.