Tread carefully and help clients see the potential CGT on second homes

The main residence (PPR) relief changes were announced in the Autumn Statement last year. The reduction in the final exempt period, from three years to 18 months, changes the Capital Gains Tax (CGT) picture for many clients significantly. CGT planning could then be reviewed alongside the mitigation of Inheritance Tax (IHT).

When reviewing the use of the main residence exemption, remember that once clients exercise their right to elect which residence is treated as their PPR, they can change that election at any time. The time limit is two years from any change in combination of residences, including rented property, with any property change starting a new two year period. It's always worth making the election, even if choosing the obvious main residence, so that there's flexibility to change it later.

An election can be for as short a period as seven days. If then reversed, only a seven day period of that property does not benefit from PPR. If a property is sold with only part PPR, there's a time apportionment to work out the PPR share of the total ownership period. A temporary "main residence" would have PPR for say seven days, plus the final exempt period, if that is three years, owning a residence for six years could mean half the gain has PPR relief. The reduction to 18 months means only a quarter gain is exempt.

Unexpected knock

Letting relief is often available as well, and many are familiar with the cap of £40k per person, but this cap depends on three elements, including the gain that relates to the period let (e.g. in the example below £100k for five tenths, restricted to £80k, i.e. the £40K each). The letting relief also cannot exceed the amount which benefits from PPR. The reduction in the last three years could have an unexpected knock on effect here.

For example, Fred and Ginger own a second property in London. After one year living in the flat, they bought a country house as their long term family home, letting out the flat for five years. They then decided to keep it for their occasional use, a good base in town, for a further four years before now selling. Their PPR would apply to four tenths of 10 years: the first year plus the last three years, if they exchange on their sale before 6 April 2014. Their gain is £200k so they would have £80k PPR. Their letting relief is limited to the cap of £80k as above.

However, if Fred and Ginger exchange contracts after 5 April 2014, they not only lose one and a half years' of PPR, which reduces the amount to £50k, (two and a half years), but their letting relief is also capped at that PPR amount, so they lose a further £30k relief between them. From today's £160k relief, with only £40k taxable gains, they suddenly have only £100k relief, with potential CGT of 28 per cent on the extra £60k.

Consider gifting shares

Gifting shares of a property, so that it is jointly owned with the family who enjoy its use becomes more attractive to mitigate the larger potential CGT on second properties. Where anyone is actually occupying a property as their main residence, it makes sense to consider gifting a share outright or to a trust for their benefit, so that PPR can be claimed-if the trust then makes a joint election by trustees and beneficiary.

For a holiday home, say Ben and Sally have three adult children, and they each own a fifth, on any future sale the gain is splintered, and each child could always share their fifth with any spouse. If all five regularly use the property, that can work well, but there are two big dangers to negotiate. One is to avoid a gift with reservation of benefit (GROB); the twin requirements for the donor to give up the actual benefit and the donee to take on that use; to avoid being caught for IHT.

The second danger to avoid is the pre-owned assets tax charge (POAC) to income tax. If something is successfully given away for IHT and then fails the POAC test, the consequence is that you then have an annual charge to income tax on the donors. The problem: the wide scope of the term "occupation" for POAC purposes. Say Ben and Sally bought their holiday home, keep the keys and use it most as they have retired, HMRC could treat them as being "in occupation" all the year when it's not used by someone else. Then the tax is based on the rental value for a much larger part of the year. So, tread carefully, help clients see the potential CGT but also consider taxes in the round. Also ensure, post Mehjoo v. Harben Barker, that you have the expertise to advise, or introduce someone who does.

John Bunker is head of private client knowledge management at Thomas Eggar

www.thomaseggar.com