Flipping’ properties and tax

You are planning to buy a cheap property, refurbish it and sell it on for a good profit. Your understanding is that as long as you live in the property, the gain is tax free, but is this correct?  Partner Christiaan Hansen explains.

There’s no doubt that buying properties, then doing them up and selling them, known as ‘flipping’, can be lucrative. But before you decide to embark on this strategy, you should be aware of the potential tax traps.

Tax-free gains
While many people do make a profit on the sale of their main home, it isn’t usually taxable because of private residence relief (PRR) which exempts the gain from capital gains tax (CGT). So, all you need to do is live in the property to make sure you won’t pay any tax on the sale, right?

Unfortunately, it’s not quite that simple. The relief is not intended to relieve speculative gains or gains arising from development and the legislation specifically prevents PRR from applying where the acquisition of a property is made wholly or partly for the purpose of selling it to make a gain.

This would appear to mean that anyone who sells their home won’t get the relief, after all, nobody buys a house with the intention to sell at a loss. Luckily, HMRC guidance recognises that anyone who buys a house is likely to hope that the value will appreciate over time and that it would be unreasonable to deny relief in those circumstances. It goes on to say that relief should only be denied when the primary purpose of the acquisition was an early disposal at a profit.

EXAMPLE. John is a kitchen fitter, and he buys a cheap property that he thinks will be worth £75k more once he refurbishes it. John enlists the help of his friends to install a new kitchen, bathroom and flooring. He promises to pay his friends for their labour once the property is sold. He stays in the property whilst the work is being carried out to save time. John sells the property within a few months, making £70k profit. Despite occupying the property, John will not qualify for PRR because he clearly only purchased the property so he could sell it for a fast profit.

John is trading and so the profits would be subject to income tax not CGT.

What is the purpose?
In order to qualify for PRR you would therefore need to show that the main reason for purchasing the property is not to quickly dispose of it at a profit, but to genuinely live there as your main home. You can document your intentions in email communications with your solicitor or mortgage advisor.

EXAMPLE. Janet purchased a flat because it was close to her office. The flat was affordable because it needed modernising. Janet moved in and immediately replaced the windows and doors. Over the next six months she decorates the rest of the flat. Janet sells the flat so she can move in with her new boyfriend. Despite only living in the property for a short amount of time, Janet can claim PRR such that no tax is payable on the gain because she purchased the property to be closer to work, not to make a quick profit.

IN SUMMARY
If you are only purchasing a property to make a quick profit, living there won’t make you eligible for relief from capital gains tax. However, if you’re genuinely buying a property to live in as your main home but choosing a particular property because it has potential to appreciate in value then you shouldn’t need to pay tax when you sell it.

For help and advice contact a member of the team at JRW Hogg & Thorburn.