If you’ve used part of your home for business you might have to pay capital gains tax when you sell it. Calculating this isn’t as simple as it sounds and costly mistakes are often made. How can you avoid these?
Business use
Working out the tax payable where you’ve used part of your home for your business involves what at first sight seem to be simple rules, but they include a few sneaky catches which aren’t well known or understood. It would be a fair bet that many of the calculations sent to HMRC include at least one mistake which affects the final tax bill. We’ll explain two of the most common errors so that you don’t fall into the same traps.
Basic rules
You probably know these basic principles; no tax is payable if you sell your home for more than you paid for it and it was used wholly as your main residence throughout the period of ownership or throughout the period of ownership except the final nine months. This is known as private residence relief (PRR). If it has not been your main residence for the whole time, or part of the property was used for your business, the part of the gain that qualifies is worked out by apportioning the total gain.
Example 1. Bob bought a house with six equal size rooms (ignoring the toilet) on 1 April 2016 for £200,000. He sold it for £290,000 on 31 March 2022. He always used one room exclusively for business. The legislation says the gain must be apportioned between the part of the home used for business (this doesn’t apply to employees who use their home for work) and that used as their main residence. Bob’s taxable gain is £15,000 ((£290,000 – £200,000) / 6 rooms).
Tip. If the rooms are significantly different in size it’s more accurate to apportion the gain by area.
Example 2. The facts are identical to Example 1 except that Bob used the whole house as his home for one month and then converted one room for business use. The legislation which applies here is similar but not precisely the same. Instead of apportioning the gain between the chargeable part and that which qualifies for PRR, it’s allowed for the whole gain, but adjusted to account for the business use. This might seem to boil down to the same thing except for one important factor.
Tip. No adjustment is required to the PRR for the last nine months of ownership even though part of Bob’s home was used for business during that period. HMRC confirms this in its internal instruction manual.
Bob’s gain. The taxable gain in Example 2 is therefore: PRR £90,000 (the whole of the gain), reduced because of business use, 53/72 / 6 (rooms), i.e. £11,041.
Did you spot the traps?
The first trap relates to the rule used in Example 1 (apportioning the gain) when the rule in Example 2 should have been used. This means you lose out on nine months’ worth of the exemption.
The second trap is to automatically use the number of rooms in your home to work out the apportionment or the PRR adjustment required. As indicated in our tip, you can use floor area provided that it produces a sensible and fair result.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.