Page last updated at 23:01 GMT, Thursday, 28 May 2009 00:01 UK

How to avoid tax just like an MP

Money Talk
By Sharon Bedford
James Cowper accountants

Man protests outside Parliament about MPs expenses
Avoiding tax on a second home is not just for MPs

The current controversy over MPs' expenses has highlighted the substantial tax advantages available from the "flipping" of second homes.

This is the tactic of telling HM Revenue & Customs (HMRC) that a second home is, in fact, your main residence, to avoid capital gains tax (CGT).

While MPs have now been forbidden to do this, this tax break is still available to anyone who has a second home, and who has the means to fund relatively short- term property gains.

It has long been a premise of the UK tax system that an individual is allowed to buy and sell his or her main home free of CGT.

Capital gains are generated tax-free to allow movement up the property ladder and the accumulation of equity.

However, the ability to sell a second home, avoiding tax on all the recent capital gains, relies on a new bit of the tax law which was extended during the last recession to help individuals forced to move home to find work.

On your bike

Flipping your main residence between two or more properties would not on its own result in a significant loss of tax revenues to the government.

For tax purposes the last three years of any period of ownership are treated as though you were still living there

That is because the decision is not retrospective.

If you nominate a cottage in the country as a main home just before you sell it, you only avoid capital gains tax on the increase in its value after you have told the HM Revenue & Customs that it is now your main residence.

However if flipping is combined with the so-called "time to sell" rules, significant tax breaks can result for individuals.

These mean that even if someone else is now renting your supposed main property, for tax purposes, the last three years of any period of ownership are treated as though you were still living there, and thus still qualify for tax-free status.

During the recession of the early 1980s, Conservative Employment Secretary Norman Tebbit suggested the unemployed might want to get on their bikes and look for work, to encourage migration from depressed areas to more prosperous regions of the UK.

Those who tried to move to find a job often found they faced another problem.

The depressed housing markets in some areas of the country meant they could not sell their home for a considerable time, and were forced to letting it out in the short term.

It would have been a double whammy if this letting meant they also lost their tax- free capital gains status, and hence the introduction of the "time to sell" rules.

How it works

Take the example of someone who has lived in a house for seven years, then moves away to work, or marries and moves in with his partner.

Sharon Bedford of accountants James Cowper
Sharon Bedford of accountants James Cowper

He is unable to sell his house and lets it to tenants for a further three years.

Without the "time to sell" rules 3/10ths of the gain on selling his home would have been subject to capital gains tax.

However, under the current rules, the whole gain is tax-free.

So take the example of an MP, or some other individual who needs a flat in London, such as an investment banker.

The rules state that within two years of acquiring the London flat he or she has to decide which home is their main residence.

Say they decide to tell the Revenue that it is the family home in the country, hence maintaining its tax-free status.

The flat is then sold at a profit within three years of being bought.

An election can be made, by writing to the Revenue, to tell them to flip the tax-free relief to the flat, say a week before sale.

A week later after the sale it is flipped back to the country home.

Although the flat has only been the main residence for one week, the "'time to sell" rules kick in and the whole period of ownership of the flat acquires tax-free status.

Surprisingly easy

The country home does lose relief for one week, but this is likely to be insignificant during a long period of ownership.

It is difficult to see how a government which constantly calls for a fair and equal tax system can allow this to continue

It is possible to flip between any property you own, such as a holiday cottage, but the tax savings are particularly advantageous for those buying and selling property within the three-year window.

There are other tax planning approaches that individuals may wish to consider if they have a weekend cottage and have held it for a long period of time.

It is surprisingly easy to flip property, although it is critical that election as to your principal private residence are made within the correct time frame.

Of course much of the current controversy arises because some MPs are arguably doubly advantaged.

Not only have they benefitted from the tax free gains, but the purchase or refurbishment of their London home has been funded by the taxpayer.

Nevertheless now that flipping has made the headlines it is difficult to see how a government which constantly calls for a fair and equal tax system can allow this to continue.

But let's hope that any changes to the tax law are well thought through.

Amending the three year "time to sell" rule would stop the tax breaks that arise from the flipping of second homes.

But it would seriously disadvantage those who in the current downturn really do have to get on their bike, and in the current housing market are unable to find a buyer for their home.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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