Flipping for Beginners....

Several clients have asked me how it is that the MPs can make tax free gains on a "second home" in London when HMRC surely only give you a tax free gain on your "main residence". 

Let me start by saying that what our MPs seem to be doing with their capital gains tax may well be entirely legitimate - it is the way the taxpayer is funding their lifestyles that is more probably questionable.  Indeed, what they do to avoid capital gains tax is pretty mundane and commonplace if my guesswork is correct.  

The tax angle for second homes exploits some relatively well known tax rules which allow you to "elect" a main residence and then vary it (flip it) in order to secure two specific concessions -

a. if your property has ever been your main residence (even for a few days!) the last 3 years of ownership is deemed to have been a main residence period of occupation for capital gains tax - even if you have it rented out.

b. if you let out your main residence the gain that arises in respect of that proportion can get up to 40,000 per owner in additional gains exemption.

At least I now know why this apparent "loophole" for planners has been left wide open so long.  It seems Mr Darling has been "flipping" away, if the media are telling the truth.

Example:

Sarah Sly-Cheetam is elected as an MP for Robberton & Theivem Hill.  She is married to David Sly-Cheetam and they live in a large detached villa (no moat) in the town of Cunnington which is the heart of the constituency. 

Her initial delight at being elected is tempered by having to sleep on her sister's floor for the first few weeks and despite having a generous expense claim for "rent" to her sister she decides to buy a flat in Sloane Street, west London, so she can be near John Lewis, Harvey Nicks and Harrods (where she intends to acquire furnishings for the flat and other necessities).

She and her husband buy the flat in joint names in 2004 for £200,000.  She lives in it for a year when she is made Chancellor of the Exchequer and moves to No11 (actually no10 but that's another story) Downing Street.  At this point she rents the Sloane Street flat to a friend.

Over the years the rented flat is declared to Parliament to be her second home and she claims all manner of renovations.  From time to time she tells Parliament her constituency home is her second home - it was useful in order to get an expense claim in when they wanted their ornamental ballustrades restored.  In 2009, Sarah resigns as an MP after being disgraced in a sex scandal involving the "Chief Whip".  Sarah and David sell the London flat in 2009 as her friend (who is actually another MP) who was renting it asks to buy it.

She sells the flat for £700,000 in 2009.

So, in summary, buy a flat in 2004 for £200,000, "part time" live in it for 1 year, rent it for 4 years then sell it for £700,000 in 2009.

Would it surprise you if I said that with some cunning but entirely legitimate planning there is NO tax to pay on this gain?

Well, this is "flipping for beginners" so I won't bore you too much but the short story is that through a cunning plan this level of gain over five years might attract no tax at all.  It involves making an "election" to HMRC as to which property (constituency home or the flat) is the main residence in 2004 (involving telling HMRC that the London flat is the main residence in 2004 then "flipping" the election back as little as a few weeks later but for no tax just leaving it until Sarah moves out to Downing St).  This then triggers rules that allow any property that was your main residence to automatically be given the last 36 months as a "main residence" period, AND something called "lettings relief" plus the annual exemptions - bring a taxable gain figure of NIL out. 

Computation

Gain (Mr & Mrs) -500,000

1st year  - main residence - (100,000)

last 3 years - main residence deemed - (300,000)

Lettings Relief (2 x 40,000)- (80,000)

Gain Remaining - 20,000

2 x Annual exemptions covers this - so gain = NIL, tax = NIL

These tax rules are available to you and me - although for how much longer is debatable.  However, the point here is that the real scandal is that MPs are telling the Fees Office one story (which house is 2nd home for expense claims) and presumably telling HMRC a different story to optimise their tax bill on disposal!  Some are probably just not reporting the gain at all and aren't doing these "flipping" elections for HMRC!

For "you and me", if you are buying a second home (even an investment) it is very important you consider elections - the elections will ensure that the "last 36 months" of ownership is always a main residence period - so if you buy a second home and sell it within 3 years, an election for as little as a few weeks might make the gain tax free.  Of course, there's more to it than a quick "blog" reveals - but you get the point.  But how long will this tax loophole remain......

HOLIDAY HOUSES

There's an add little change to the rules for holiday letting.  At the moment if you have furnished holiday lets you might be enjoying some quite generous tax rules including relief against capital gains as "trading" assets.

On the right hand side of our website in the documents section we've put an important note on the changes that are in the pipeline - which will do away with the concessionary tax breaks this type of investment enjoys.

VAT FOR BUSINESSES

In these harder times, clients are looking to save cash.  VAT is often overlooked in tax planning and it might be worth me pointing out a few VAT mistakes that can be rectified and allow reclaims -

• staff entertaining is vat allowable (not client/customers though unless they are foreign customers!)
• input tax on fuel used by staff on business (i.e. within a mileage claim) is recoverable even if they drive their own car.
• pre-registration input tax is often claimable -3 years for goods and 6 months for services.
• leased cars-  50% input tax recovery (100% if lease <10 days).
• bad debts -vat recovery after six months overdue for payment.

And remember to consider carefully your vat cut off and processing procedures to ensure all your input vat for the quarter is properly in the return.  If you normally get repayments move to monthly returns.  And, finally, don't forget the "business support service" HMRC operates extends to VAT - so it is usually possible to spread your tax payments without penalty at this time (interest taken at a commercial rate).