Last updated: May 22, 2009 10:01 am

Tax clampdown on second homes to hit workers and couples

Relocated workers, newly married couples and part-time property developers are more likely to face a tax bill when they sell their properties – as a result of the controversy over the ‘flipping’ of second homes by MPs.

Tax experts warned this week that the rules allowing homeowners to ‘flip’ the status of a second property to that of a ‘principle private residence’, to claim exemption from capital gains tax (CGT), will almost certainly be tightened in the coming months.

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“When Gordon Brown stands up and says he wants a fair and equal tax system, I can’t see how it can be allowed to carry on,” said Sharon Bedford, tax partner at accountants James Cowper. But Patricia Mock, private client services director at Deloitte, pointed out that any clampdown would adversely affect the homeowners that the rules were intended to help. “I suspect it is on the cards – but it is hard to see how they could tighten it up without affecting the genuine person moving from one part of the country to another.”

The current rules date back to the last recession, and were designed for individuals forced to move home to find work. They allow homeowners moving out of a property, but unable to sell it, to elect that property as their tax-exempt principal residence, even if they no longer live there. This exemption can apply for up to three years, under a concession granted in the last housing market downturn, giving owners “time to sell”.

“During the recession of the early 80s, Norman Tebbit suggested the unemployed may want to ‘get on their bike’ and look for work, to encourage migration from depressed areas of the UK to more prosperous regions,” explained Bedford. “Those who did have to move to secure a job often faced another problem. The depressed housing markets in some areas of the country meant they could not sell their home for a considerable time and may have been faced with short term letting. It would have been a double whammy if this letting meant they also lost their tax free status, hence the ‘time to sell’ rules. The last three years of any period of ownership of a residence should qualify for tax free status.”

Couples who each own a property, but move into one of them after marrying, also benefit from these rules at present. They have this ‘time to sell’ their second property tax free – as they lose their individual exemptions on marriage. “Once they get married, they have just one principal private residence exemption between them,” explained Mock. “But then they still get the other three years.”

Even amateur property developers, who buy properties to refurbish and sell on, can claim the exemption if they live in the property for a few weeks. “These tax breaks are not exclusive to MPs and can be exploited by anyone who has a second home and the means to fund relatively short term property gains,” said Bedford.

However, following the announcement by House of Commons leader Harriet Harman that MPs are to be banned from ‘flipping’ the status of second homes in 2009/10, HM Revenue & Customs is expected to amend the rules for all homeowners.

“One way they might tighten the rules is to say you can’t decide which is your principle private residence – it has to be factually your main residence,” suggested Mock. “Or they might say that, once you have made an election, you can’t vary it.”

Bedford at James Cowper agreed. “HM Revenue & Customs could get more aggressive in enquiring if you really live there, or announce a change in legislation overnight,” she said. “Amending the three year ‘time to sell’ rule would stop the tax breaks from the ‘flipping’ of second homes but would seriously disadvantage those who in the current downturn really do have to “get on their bike” and are unable to find a buyer for their home.”

A spokesman for HM Treasury said the current rules were being “kept under review on an ongoing basis.”

 How does ‘flipping’ a second home work?
 

Mr Smith owns a large house which is his family home. He then purchases a flat near his place of work.

As he owns two properties, he can elect which of them is to be treated as his principal private residence (PPR) and exempted from capital gains tax (CGT).

So, within 2 years of acquiring the flat, Mr Smith nominates his family home as his PPR.

But, after two years and ten months of owning the flat, its value has risen by £50,000. So Mr Smith decides to cash in by selling the flat and realising the profit. This would normally be liable to CGT, but the rules allow Mr Smith to elect that the flat is treated as his PPR and to backdate this – so that up to three years are exempt from CGT. This means he does not pay tax on the £50,000 gain.

He may then be worried about the loss of the PPR exemption on his family home. So he ‘flips’ his PPR election again – within a week . And again, he benefits from a backdated period.

As a result, the gains realised on both properties are kept exempt from CGT – apart from one week’s worth of gains on the family home, which is taxable.

 Source: James Cowper

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