You’ve converted a room in your house into a study so that you can work at home more often. A colleague tells you that this can mean that you’ll lose some of the capital gains tax relief that usually applies to homes. Is he right?
Working from home
As the owner manager of a business working at home is part of the job. The trouble is that doing so can mean the usual tax-free status, which applies to any capital gain you make when you sell your home, is lost. The tax rules which cause the loss of relief work in two different ways, and are often misunderstood.
It doesn’t apply to directors
The most common misunderstanding concerns the rule which says if you sell your home for more than you paid for it, the gain relating to the part exclusively used for “trade or business, or of a profession or vocation”, must be worked out separately and cannot qualify for capital gains tax (CGT) private residence relief (PRR). This rule only applies to sole traders and business partners, not to directors or employees.
What’s the position for directors?
It might seem from the above that directors can use part of their home for work and any gain they make when they sell will qualify for PRR and be tax free. However, a second rule prevents this.
If you use part of your property for any purpose other than as your home, HMRC can reduce the amount of PRR you qualify for. Setting aside a room in your home for work would clearly seem to jeopardise PRR.
HMRC’s view of the law
Surprisingly, HMRC takes a generous view of the second rule. In its guidance to tax inspectors it says “No adjustment” to reduce PRR “should be made where, for example, a room is used as a study”. However, it goes on to say “If a substantial part of the residence is used exclusively as an office” then PRR should be restricted. Take advantage of HMRC’s approach by limiting exclusive use for work to no more than one room in your home, that way you won’t lose any PRR when you sell it.
What if you use more than one room?
If you use more than one room in your home for work, HMRC will expect you to reduce the amount of PRR that you claim when you sell it. However, you shouldn’t be too worried about this. In our experience the risk of a large CGT bill is small because the rules say that the amount of PRR allowable should be reduced using a “just and reasonable” calculation.
Example. Tim, a director of Acom, sells his house and makes a gain of £250,000. He owned it for 15 years and for ten of them exclusively used 15% of it for work purposes. PRR would normally cover the whole £250,000 gain, but a just and reasonable reduction would be £250,000/15 years x 10 years x 15%. That produces a figure of £25,000 which is the amount of gain to which PRR won’t apply. But because Tim is married, and he and his wife have their annual CGT exemption (£11,100) available to set against the gain, only £2,800 of it is taxable resulting in a maximum CGT bill of just £560. Hardly much to worry about.
HMRC accepts that a director can use a single room in their home as a study without losing any capital gains tax (CGT) private residence relief (PRR). However, if you use more of your home for work then some PRR is lost, but this rarely results in a significant CGT bill.