Tax Talk – Main Residence Tax Relief

Tax Talk is a series of articles brought to you by FSL’s own Tax specialist, Alex Ranahan.

A couple of weeks ago, a piece in Taxation magazine got me thinking.  It was about the tax relief for selling your main home (the tax technical name is Principal Private Residence relief or PPR relief) and how that relief may be adversely affected by our new age of working from home.  This interested me a great deal more than usual as I have recently bought my first home and am home-working.  Obviously, I don’t expect to sell up for a while – but it never hurts to give these things due consideration.

A recent issue of Taxation magazine contained a discussion about the way that setting up an office room for home-working might inadvertently lead to a future tax bill when you sell your home.  There is a longstanding law that when you sell your main or only home, you do not have to pay Capital Gains Tax (CGT) on any profit.  This relief is so common that many people would not even consider the tax consequences of selling their home.

However, some restrictions to this relief exist in order to ensure that it is not a straightforward exemption to tax on the sale of any residential property at all.  For example, the sale of a holiday home or a property which is let out would be charged to CGT.  One little known restriction is that where part of the home is used exclusively for business purposes, a proportional part of the profit on sale is not given main residence relief and is subject to CGT.  This often affects GPs and dentists who use a room in the home exclusively for surgery.  However, this restriction could also affect those of us who frequently or wholly work from home rather than in the office.

The rule is very clear:  The restriction will only apply where the part of the home “is used exclusively for the purpose of a trade or business, or of a profession or vocation” (TCGA 1992, s.224 or consult the HMRC manual CG64663).  That is, the room in the home must be used exclusively for work purposes with no personal use.

The Taxation discussion suggests that personal furniture, equipment and other belongings should be kept in the home office, and one should use the room for personal use as well as work use.  As CG64663 above states, “occasional and very minor residential use should be disregarded”, so one should ensure that the room is clearly set up and used for personal reasons as well as business reasons.

Of course, this is not to say that HMRC can see what you do in your home at every moment, nor is it to say that you should reorganise your home simply in order to avoid tax.  Personally, I sometimes try to avoid using the room I’m in now outside work hours as it helps my mental health to compartmentalise, but I do have my personal computer in here too for frequent use.  The point is simply to make you aware that this is a restriction that exists and that you should be mindful of a potential consequence of setting up a room in your home exclusively for work purposes.

As pointed out by the correspondent Sam Wightman @ Jerroms in that Taxation piece, were HMRC to try restricting relief to people when there was no alternative, or when they were forced to work from home, there would be strong opposition and it would be unlikely to be enacted.  One-third of the British workforce worked from home during the height of COVID-19 restrictions, and of course we are currently seeing huge numbers of property sales and skyrocketing house prices.  Would the Government impose a tax bill on those who sold their home during a pandemic or its immediate aftermath, when they were forced to work from home?

Few openly suggest abolishing main residence relief altogether.  The relief has existed since CGT was first introduced in 1965 and it has persisted through governing parties of all stripes.  We know from the Office of Tax Simplification’s second report on CGT that in 2018/19, around 85,000 of the 150,000 individuals who disposed of a residential property actually paid CGT on it, and only 9,000 of those got partial relief.  Huge numbers of taxpayers benefit from the relief every year.

HMRC’s estimate of the CGT it missed out on in 2020/21 thanks to this relief was £28 billion.  For reference, their report of CGT paid on residential property sales was £1 billion in 2020/21 while the Health & Social Care Levy and dividend tax rise starting in April are together expected to bring in around £12 billion per year.

If the preceding two paragraphs of statistics have made your eyes glaze over then I’ll summarise.  Only a very small proportion of residential property sales currently require a calculation of partial CGT liability, because the rest is covered by main residence relief.  The majority of sales are not charged to CGT at all.  To penalise those who work from home for the sake of whatever proportion of the property their ‘home office’ takes up, out of the total capital gain, would be a nightmare both for the taxpayer to calculate and for HMRC to administrate.

The extension of the tax relief on expenses for working from home was a welcome respite during a difficult period, although personally I do think that much of the promotional legwork had to be done by social media and influencers like Martin Lewis.  Now we have an area of potential confusion, even conflict, between taxpayers and the tax authorities.  I hope HMRC and lawmakers issue guidance on this issue soon to make the position clear for taxpayers and catch up with modern ways of working.

Please remember, this is not financial or tax advice.  Please consult a qualified adviser for further details.