PRR: how will your clients be affected?

Next year a number of changes to private residence relief (PRR) are expected. The two headline changes are the reduction in the final exemption period from 18 months to nine months and the introduction to letting relief of a shared occupancy test.

While PRR might be a relief that is often taken for granted, it affects the most substantial asset many people will ever own. We had the first sight of draft legislation in July 2019 and the ATT responded at the end of August. If the draft measures are implemented on 6 April 2020 as they stand, how will your clients be affected?

Final exemption period

The final exemption period allows individuals a period of grace to sell their home after they have moved out. While it is more usual to sell one property before buying another, sometimes individuals are forced by personal circumstances to move out before they can sell their previous home. Under the provisions of the final exemption period, as long as the property has been their main residence at some point during their ownership, the individual is deemed to be in occupation for the final months regardless of whether or not they actually were in occupation.

From the Government’s perspective, some individuals with multiple residences have been taking advantage of how this relief is structured by transferring main residence elections between properties in a practice known as flipping. The changes are intended to “to better target the exemption at owner-occupiers” by reducing the benefits of flipping. The period of nine months is justified as being in excess of evidence that the Government has received suggesting that properties take an average of 19 weeks to sell.

A number of representative bodies, including the ATT, have commented that the proposed nine-month window is too short – especially with the uncertainties of EU Exit –  and that there are other ways in which the perceived avoidance from flipping could be avoided.

Concerns have also been raised about the 19-week average sale time figure used as justification for the change. The basis of the statistic is unknown, and an average hides the effect of a number of variables which may affect the time to sell, such as location, time of year, price bracket etc.

In practice however, number crunching suggests that property gains will generally have to be fairly substantial to trigger significant amounts of tax when PRR is otherwise available for the rest of the ownership period. This means that for many homeowners who struggle to sell, the main issue may not be the actual quantum of any additional tax generated by the measure, but the new requirement to report and pay within 30 days of completion if any tax does arise. These new reporting rules for residential properties have already been legislated and will also come into effect from 6 April 2020 for UK residents. (Non-UK residents disposing of UK residential property have been required to report their disposals within 30 days since 6 April 2015.)

Letting relief

The Government also intends to restrict letting relief to situations where both the homeowner and their tenant are occupying the dwelling at the same time.

No transitional measures are proposed and this measure has quite a severe cliff-edge effect, since it effectively removes letting relief retrospectively for those whose past lettings do not meet the new conditions. For a higher-rate taxpayer who was expecting to benefit from the maximum potential relief on up to £40,000 of gains, this measure will cost them an extra £11,200 in tax overnight.

In addition to the requirement that the homeowner is in residence with their tenant, the letting must also be “otherwise than in the course of a trade or business”. This is an unexpected qualification, which was not raised during the consultation period. This makes the scope of the new letting relief unclear and could give rise to some potentially difficult questions of fact – since providing definitive guidance as to when a trade or business exists could be challenging.

The restriction also operates more widely than anticipated. Currently letting relief is available for the provision of residential accommodation. This means that some guest houses and B&Bs can qualify for letting relief where their let rooms are not used exclusively for business purposes. The residential accommodation definition also covered those providing more informal lettings via AirBnB.

Under the new conditions, guest houses and B&B which amount to businesses would no longer qualify for letting relief, while anyone carrying out AirBnB letting would need to consider if the scale of their operations amounted to either a trade or business.

It is important to note that those with a ‘traditional’, long-term lodger can still potentially benefit from the provisions of Statement of Practice 14/80 (SP 14/80). Where the conditions are met, SP14/80 allows a homeowner to continue to claim PRR despite the presence of a lodger, and removes the need for recourse to letting relief at all.

However, at nearly 40 years old, SP 14/80 no longer reflects the modern lodgings market and there are a number of situations which do not fall within HMRC’s narrow interpretation of the concession so care must be taken. As part of their response to the draft legislation, the ATT has called for the statement to be updated.

The next steps

The consultation on these, and other proposed changes to PRR, closed on 5 September 2019. Assuming that draft provisions reach Finance Bill 2019-20, we will then need to see what, if any, changes are made to them either before then, or during the usual Finance Bill debates that follow.