Capital gains and second homes

Most people know that any gain they make on selling their main home is tax-free, while a gain on selling a second home is subject to tax. However, careful use of the “main residence election” can result in gains on sales of more than one property being tax-exempt.

If you have more than one home, one of them will be your “main residence”. If you sell your main residence and make a gain, that gain is tax-free. If you don’t make an election to determine which is your main residence, HMRC will form a view on the basis of the following criteria:

• What address is shown on tax returns?
• What address is shown on third party correspondence that HMRC hold, such as dividend warrant counterfoils?
• What security of tenure do you have in respect of each residence?
• How is each residence furnished (if you rent a furnished flat this may be less likely to be your main residence if you have your own furniture in another property)?
• If you are married or in a civil partnership where does the family spend its time?
• At which residence are you registered to vote?
• Where is your place of work?

This may give a less advantageous outcome than making your own election, for example if one property is in an area that has had rapid growth in house prices. What is more, it is possible, though perhaps rare, for a property that you only rent to be the main residence on the above criteria.

There is a strict deadline for making an election for a particular property to be treated as your main residence. The deadline is two years from the date when you first have a second residence. However, if you acquire a third residence this starts another two-year period running, and so on, and similarly if you cease to have one of a number of residences. The important points to note here are:

• you can only include genuine residences in the election (holiday homes and buy-to-let properties generally can’t be included); and
• the two-year time limit starts from the date when the new property becomes one of your residences, and not from the date you first own the property if that is earlier.

Once you have nominated a property as your main residence, you can vary the nomination at any time, backdated for up to two years. In addition, once you have lived in a property as your main residence, any gain in the last three years of ownership will be tax-free, even if you have a different main residence in those three years.

These rules create the following opportunity. Suppose you buy a second home in a high-growth area on 1 May 2007. You then have until 30 April 2009 to nominate either of the two homes as your main residence. Suppose you nominate the new property. You can then change the nomination back to the original home at any time. So you could change the nomination on or before, say, 15th May 2009, backdated to 15 May 2007. If you sell the high-growth property on or before 30 April 2010, the entire gain on that property will be exempt under the “last three years” rule. Meanwhile, the original property is growing in value tax-free for all but two weeks.

This idea is actually set out in HMRC's own manuals. The key is to make sure that you make the original nomination in time. If you don’t do anything until after 1 May 2009, you are too late and the gain on the high-growth property will be taxable. If you need advice on the issues surrounding the main residence election, speak to Richard Whitelock or David King in our tax department.