When does dwelling ownership begin for PRR purposes?

The facts

In October 2010 Mr and Mrs Lee (L) bought a property and soon after had it demolished. They never lived in it. They built a new property on the land which was completed in March 2013. They occupied the property as their home until they sold it in May 2014, making a capital gain in the process of more than £550,000.

The dispute

The Ls claimed capital gains tax private residence relief (PRR) on the whole gain they made from the sale meaning that there was no tax for them to pay. HMRC refused part of the claim saying that as the Ls had owned the asset for 43 months (from October 2010) and occupied the dwelling for only 15 months, PRR only applied to 15/43rds of the gain. HMRC amended the L’s tax returns to reflect this and so they appealed to the First-tier Tribunal (FTT). The outcome of the case turned on whether for the purposes of PRR the ownership period started in 2010 when the old property and land was purchased or when the Ls first occupied the new property as their home, which was soon after the construction was finished.

HMRC’s arguments

HMRC’s main argument was that the building and the land on which it was sited was a single asset. It said that if the building and the land were treated as separate assets the Ls would be “having it both ways”. Specifically, in calculating the gain the Ls correctly deducted the costs of creating the new dwelling but also were claiming PRR for the growth in value of the land prior to it containing the main residence. Secondly, HMRC said that if its main argument failed, the PRR legislation states that where a taxpayer has “different interests” in a dwelling at “different times” the ownership period begins from the start of the earliest interest (which it said was 2010). To support both arguments HMRC cited previous decisions with similar but not identical facts.

FTT’s deliberations

The FTT easily dismissed HMRC’s second argument as a misreading of the legislation. It clearly only applied where a taxpayer has had different legal entitlements to the property at different times, e.g. where the taxpayer owned a lease on a property and later purchased the freehold.

The FTT acknowledged that HMRC’s first argument that the sale of a building includes the land it occupies. It then considered the case law HMRC had cited but found that neither it nor the legislation clearly defined what a “dwelling” was for the purposes of PRR. It decided that the usual meaning of the word referred to the building itself and by inference the land it sat on. Therefore, the fact that the Ls made a gain on the land prior to occupying the property was irrelevant. PRR applied to the combined gain. The FTT therefore ruled in favour of the Ls.

As the ruling is only at the FTT level it does not set a precedent. However, the analysis of the issues might be helpful for anyone who buys land and constructs a home on it.