You are selling your home, which incorporates an annexe. You realise that some of the gain you make won’t be covered by private residence relief (PRR). How do you calculate it and should it be reported to HMRC?
If you make a gain from selling a residential property, e.g. your home, you must report it to HMRC and pay the tax with 60 days of completion. No report is required if there’s no tax liability, e.g. because it’s covered by private residence relief (PRR) . However, if all or part of the property has not been your only or main private residence for some or all of the time you’ve owned it, PRR may be restricted and so leave a taxable and reportable gain. That was the position a married couple found themselves in.
Property history
Five years after buying their home they converted the garage to an annexe intended for use by an elderly relative. Unfortunately, she died before it was ready. They used it as living accommodation before letting it between February 2014 and January 2023. Since then it’s been used as part of the main home. The house and annexe are being sold together. Despite reading HMRC’s guidance they are unsure if they need to report part of the gain within the 60-day limit.
Two rules
There are two tax rules for working out PRR that come into play when part of your home is used for purposes other than as your only or main residence. These are easily misunderstood.
The first rule requires you to work out the capital gain relating to the part of the property which has been used exclusively throughout your ownership for a purpose other than as your only or main residence (and therefore by implication the gain relating to the rest of your home). None of that gain qualifies for PRR while all of the remaining gain from the sale of your home does. The second rule applies only where you have used part of your home other than as your only or main residence for some of the time in which you’ve owned it. In that case you don’t work out the gain for each part of the property but for the property as a whole. However, you must “adjust”, i.e. reduce, the PRR to take account of the period that part of it wasn’t used as your home.
Trap. It’s important to identify which rule applies. Choosing the wrong one can result in calculating the gain incorrectly and so either paying too much tax or not realising a gain needs to be reported, which in turn could result in financial penalties.
Mixed use over time
Because the part of the property causing the trouble had different uses at different times, including periods when it was used as their only or main residence, the second rule applies. The bad news is that this is likely to result in a larger taxable gain.
Tip. The rules don’t specify a method for working out the adjustment to PRR. It can be calculated according to floor area for the respective parts of the property or any other way as long as the outcome is “just and reasonable”. That gives them scope to minimise the reduction in PRR, and importantly put them in a position to decide if they need to report the gain to HMRC.
There are two methods of calculation, one involves working out the gain on the part of the property not used as their home separately from the rest of the gain. The other involves calculating the whole gain but restricting PRR. As these can result in different taxable gains, it’s vital to identify which applies. In this case it’s the latter.
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