TT11: Taxation of Second Homes

It is usually taken for granted that the family home can be sold without any capital gains tax (“CGT”) problems. This is because there is a generous CGT exemption for your “only or main residence”.

In fact, the rules are quite complex and there are a number of pitfalls into which the unwary can stumble, particularly with regard to larger properties, so it is perhaps slightly cavalier to suggest that such properties can be sold without any problems arising. Generally though, the position is relatively simple when dealing with a straightforward sale of the family home.

Conversely, it is often assumed that a sale of a holiday home cannot be tax-free because whilst it might be a residence, by definition it will not be “only or main”. It is possible, however, to elect to treat a property that is a second or holiday home as the “only or main” residence, thereby exempting it from CGT. But if one elects for the holiday home to be CGT exempt, doesn’t that mean that the main family home will then become chargeable to CGT? Surprisingly the answer is probably not!

Yes, a holiday home can be tax-free!

You can take advantage of two inter-related issues. The first is that once a valid election has been made to treat one or other of the properties as the main residence for CGT purposes, you can then chop and change the election as often as you wish, so one property can be nominated as the main residence one day and the next day the election can be switched to the other property.

However, if no valid election is made in the first place, the main residence is determined on the facts – and the facts usually will be that the holiday home will not be “main”. Thus, to preserve flexibility, a suitable election must be made in time. The Inland Revenue’s rule is that the election must be made within two years of acquiring the second residence.

The second and crucial point is that if a property has been deemed to be the main residence for any period of time, no matter how short, the CGT exemption applies not only to that actual period of time, but also to the whole of the last three years of ownership of the property.

Thus, if a holiday home had been owned for say four years and it was decided to sell it (perhaps to buy another one), if it had been subject to a main residence election for say the first 3 months of ownership, more than 80% of any gain would be exempt CGT (and the balance might be covered by annual exemptions). If no valid election had been made, of course the whole of any gain would be liable to CGT.

Importantly, the loss of 3 months of the CGT exemption in respect of the family home is unlikely to affect materially its CGT exemption, particularly if it will be owned for a long time.

Barnes Roffe Topical Tips

  • This is a most valuable planning strategy if you are considering buying a second home.
  • It is vital that you make a valid main residence election within two years from acquiring the second property.
  • The election should nominate the second home as the main residence but should be changed back in favour of the family home after a short period of time (say one month).
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