Stamp Duty Land Tax 3% surcharge ‘Replacement of only or main residence’ and the three-year rules

The higher rates of Stamp Duty Land Tax are intended to apply to purchases of additional residential properties, such as second homes and buy to let properties.  The design of the surcharge is however more complicated than one might expect.  One of the areas which causes the greatest difficulty is the exception from liability to the 3% surcharge for transactions which involve the replacement of the buyer’s only or main residence and the associated three year conditions.

This exception can save buyers paying the surcharge in some situations where they have another property, or even a portfolio of other properties.  The technical rules often have seemingly arbitrary results which are hard to justify in policy terms. Even HMRC struggle sometimes to apply them properly as is demonstrated by the CASE STUDY HERE, which deals with a case where a taxpayer had lived in another property she owned before a former home was sold and a new house bought.

Recently we have published a set of 20 case studies on the 3% surcharge, many of which deal with the replacement exception.

The focus of this article is on the three year rules as they apply for the exception to the 3% stamp duty land tax surcharge for the replacement of an only or main residence. This article has been updated to take account of the changes made on 22 November 2017, the transfer of the HMRC guidance into their Manual at the end of March 2018, improvements to that guidance up to August 2018, the changes made on 29 October 2018 and the ending of a transitional period on 26 November 2018.

Recovery of surcharge where the old property is sold after the new one is bought

We are looking here at a case where someone sells their old home (a former only or main residence) after buying a new home, intending the new home to be their only or main residence.  The buyer might own other properties as well.

Whether or not the buyer owns other properties, “at the end of the day of the transaction” on which the new house is bought, the buyer will own two or more dwellings (at least the old home and the new home).  So the 3% SDLT surcharge is due on the purchase of the new home.  The question is whether the surcharge can be reclaimed if the old home is later sold.

For this situation, the three year rules have applied from the time the 3% surcharge was introduced on 1 April 2016.  The statutory conditions for having a right to reclaim the surcharge can be summarised as:

(a)  On the completion of the purchase of the new home the buyer intends to live in the new home as the buyer’s only or main residence.

(b)  Within the next three years the buyer (or their spouse or civil partner) sells or otherwise disposes of the old home.  For purchases completing on or after 22 November 2017 changes mean that following that sale or disposal neither the buyer nor their spouse or civil partner can retain the old home nor any share in it. (I see that HMRC have a different view as to how these changes take effect, SDLTM09800 says they apply if the later sale completes on or after 22 November 2017.)

(c)  At any time within the three years leading up to the purchase of the new home, the buyer lived in the old home as the buyer’s only or main residence.

The old home could be anywhere in the world, so long as it is owned on the basis of a freehold or a lease for over seven years (or a share in such a property), or an equivalent in the local jurisdiction.

So there always have been two distinct three year tests to contend with where the old property is sold after the new one is bought:

This can hit hard those who have already let out their old home for a while.

Three year rules now in place if the old home is sold at the same time or before the new home

We are looking here at a case where someone sells their old home at the same time as or has sold their old home before buying their new home, but has interests in other properties that would mean that the 3% surcharge could be due.

This is the area that perhaps causes the most confusion but can save buyers from paying the surcharge in unexpected situations. For purchases completing after 26 November 2018 there are two three year tests, rather like the ones in place now for the recovery of the surcharge described above.

A buyer escaped the surcharge for a purchase which completed by 26 November 2018 if the following conditions (paraphrasing the wording of the legislation) were met:

(a)  On completion of the purchase of the new home the buyer intended to live in the new home as the buyer’s only or main residence.

(b)  In a transaction on the same date or earlier than the purchase of the new home the buyer (or the buyer’s spouse or civil partner at the time) disposed of a major interest in another dwelling (“the sold dwelling”).

(ba) Immediately after that disposal neither the buyer nor the buyer’s spouse or civil partner retained a major interest in the sold dwelling (this was introduced for purchases completing on or after 22 November 2017.)

(c)  At any time before completion of the purchase of the new home the buyer lived in the sold dwelling as the buyer’s only or main residence.

(d)  At no time on or after the disposal of the sold dwelling has the buyer (or the buyer’s spouse or civil partner) acquired a major interest in any dwelling with the intention of living in it as the buyer’s only or main residence.

As before, the sold dwelling could be anywhere in the world.

So even a sale years ago of a previous main residence could have been available to help gain the benefit of the replacement of only or main residence exception, so long as the purchase of the new home completed by 26 November 2018.

For purchases completing after 26 November 2018 conditions (b) and (c) are toughened by adding three year rules.  To pass condition (b) the disposal of the old home had to have completed within the three years before the purchase of the new home.  To pass condition (c) the taxpayer must have lived in the old home as their only or main residence at some point within the three years leading up to the purchase of the new home.

Only for individuals

The replacement of only or main residence exception is only available for purchases by individuals, not for example by purchases by companies or housing associations.  Nor would it apply to someone buying a property jointly with an institution, such as the Church or a University.

A discretionary trust cannot rely on the exception, even if it is to replace a home for one of its beneficiaries (such as a disabled person who is often the beneficiary of a discretionary trust).

For some other trusts, such as where a beneficiary has a right to live in the property for life or has a right to income, one looks at the circumstances of the beneficiary to see if the surcharge is due.  So a trust with a beneficiary having a life interest may be able to replace the home of the beneficiary by a sale and purchase without the surcharge being due even if the trust or beneficiary owns other property.

Remember that for those with spouses or civil partners, their other halves are normally treated as if they are also a buyer of the property being bought, even if they are not a joint buyer.  Also note that with joint buyers one applies the SDLT surcharge tests to each buyer as if they were a sole buyer.  If for any of the buyers the surcharge would be due, then the surcharge is due on the whole purchase.

These rules (and some other features of the surcharge) can be illustrated by the following scenarios.

Scenario 1: Single person returning to the UK

Question

I am a single person and returned to the UK from France in 2018. I used to live in my own house in London (my only residence at the time) which I sold in 2013. I then moved to France and lived in rented accommodation. I bought a small flat in Paris whilst I was in France to rent out, but never intended to live in it.  That is now worth well over £40,000 and I am keeping it. I also inherited a one third share in a house in Cardiff from my father two years ago.  I paid £200,000 for a house I bought in Southampton to live in as my only residence. I completed in June 2018 and was told I had to pay the higher rates.

Paragraph 3.20 of the HMRC Guidance Note of 16 March 2016 on “higher rates for purchases of additional residential properties” suggests that I had to pay the 3% surcharge on the whole price of the Southampton house, costing me another £6,000.  It suggests the replacement of main residence exception does not apply because the sale of the London house was more than three years before (and also because I had not lived in the London house at any time in the last three years). I also find the guidance on this issue as moved into the HMRC Manual confusing. 

Did I have to pay the surcharge?

Answer

Immediately after the purchase of the Southampton property you had interests in three dwellings: the new Southampton one; the let Paris flat and the inherited property in Cardiff.

The inherited Cardiff property did not count against you because it has been inherited in the last three years and you have less than a 50% share in it.

The Paris flat, however, did count against you as your interest is worth more than £40,000.  It does not help you that it is an overseas property.  So the surcharge applies to your Southampton purchase unless something else saves you, like the “replacement of only or main residence” exception.

The replacement of only or main residence exception should help you here. You mention paragraph 3.20 of the guidance, published 16 March 2016 but if you read on to paragraph 3.22 you will see that the three year rules do not apply for acquisitions by 26 November 2018. The replacement was not “used up” by your later purchase of the Paris flat as you never intended to live in it.

So as you completed the purchase of your new Southampton house to live in by 26 November 2018 you should not have paid the surcharge.   You should seek to recover the extra 3% from HMRC. There was only twelve months to amend your return; as you completed the Southampton purchase in June 2018 you are now out of time for an amendment.  Overpayment relief has a four year time limit, so you should apply to HMRC on that basis.

HMRC updated their Guidance Note on 29 November 2016, then moved the guidance into the Manual in March 2018.  At first they made a poor job of it, but corrections were made in August 2018 and these rules are now explained quite clearly in SDLTM09800.

There are some similarities to Scenario 1 in the CASE STUDY HERE about Katherine.  That was updated in December 2019 as referred to in the CASE NOTES, see the entry of 12 December 2019 when it was reported that HMRC had agreed to pay Katherine’s legal costs.

Scenario 2: Buying a new main residence and an investment property

Question

My husband and I have recently sold our home in London and have a substantial sum of cash from that, but no other property interests anywhere in the world. We are now moving out to the country and are looking to buy two properties: a flat to let out and a house for us both to live in. They will be entirely separate transactions and we expect to be buying from unconnected sellers. We will pay more than £40,000 for each of them.  Both will be in England.  Will either or both purchases be subject to the surcharge?

Answer

The surcharge position oddly depends on the order in which you buy the properties.

(a)  House first and the flat later (or if you buy them both on the same day).

On the purchase of the house, the surcharge will not be due as at the time you will only have an interest in one dwelling (or if you buy the house and flat on the same day you will benefit from the replacement of only or main residence exception for the house).

However, when you buy the flat, you will have interests in two dwellings, each worth over £40,000.  The replacement of main residence exception is not available as you do not intend to live in the flat but to let it out. The surcharge will apply to the purchase of the flat.

(b)  Flat first and then the house on a later date.

The flat will escape the surcharge because on the day of completion of that purchase you will only own one property. Even though it is to be let out, the surcharge does not apply.

When you later buy the house to live in, you will have more than one property, but you can rely on the replacement of main residence exception, so long as you never intended to live in the flat but always intended that as an investment to let out.  You would also need to complete the purchase within three years of having last lived in the London property.

So doing the transactions in this order means neither purchase is liable to the surcharge.

NOTE: The Welsh Land Transaction Tax, in effect from 1 April 2018 has provisions for Welsh purchases which impose the higher rates on the flat when the house is later bought.

Scenario 3: Couple coming together but retaining one of their properties

Question

I married last year. Both my wife and I previously owned our own separate properties which we lived in as our respective only homes. For the last year we have lived together in rented accommodation, renting out our own houses, but we are now buying a house together. The plan is for my property to be sold to fund the purchase but for my wife’s house to be retained and let out. We together own a French holiday home, it is only worth £70,000 and we own it in equal shares. I own another flat which I have always rented out.  It is worth over £40,000. It would be possible, if it helped escape the surcharge, for the new property to be bought entirely for the benefit of just one of us. Are we liable to the surcharge in this case?

Answer

In the case of joint owners, one has to look at each joint buyer separately and see whether the 3% surcharge would apply on a purchase by that person.  If the 3% would apply to either party, then the 3% surcharge applies to the whole of the transaction.

(a) Applying the test firstly to you, assuming that you are able to sell your previous house, then you still own other property interests.

The half share in the apartment in the French holiday home does not count against you because your share is worth less than £40,000. But you own the flat that you let out.  To escape the 3% surcharge you need to benefit from the replacement of only or main residence exception.

It does not matter that your previous house has been rented out for a period before its sale, it used to be your main home and you intend to use the new property as your main home. You should therefore benefit from the replacement of main residence exception. (Note: Do watch the three year rules though as your purchase will be completing after 26 November 2018.)

(b) Applying the test secondly to your wife, she retains her separate property that she used to live in, so she has an interest in more than one property after the transaction.  She would not benefit from the replacement of only or main residence exception on her own as she is keeping her main residence. If she had lived with you in your house as her main residence, then she could benefit from your sale, but this is not the case from what you say.

It therefore seems that the purchase will be liable to the surcharge.

It would make no difference if the new property is bought for the benefit of just one of you.  This is because (where a person who buys a property is married or is in a civil partnership and they live together) the spouse or civil partner is taken as being a joint buyer for the purposes of assessing whether the 3% surcharge applies, even if they are not actually a joint buyer.

Scenario 4: Order of Transactions and Effect of Exceeding Three Years

Question

I am single and own a house which I bought 10 years ago and which I last lived in as my only home two years 11 months ago.  I have let it out since and have myself been renting as I had to move for my job. I also own a flat which I bought 15 years ago; it is let out and I have never lived in it. I am now in the process of selling the house and buying an apartment to live in as my only residence.  I will keep the let flat.  I am not sure if I will be able to sell the house at the same time as, or before, buying the apartment. I have the funds available to complete the purchase of the apartment before selling the house if necessary. What is the position as to the 3% SDLT surcharge?

Answer

This depends on two things: whether you end up buying the apartment before selling the house and on whether the purchase goes through within three years of you last living in the house (there is only one month to go before the three years is reached).  So that gives four combinations to work through.

(a)  Apartment bought first, but more than three years after you last lived in the house.

You will have to pay the 3% surcharge on the acquisition of the apartment and will not be able to recover the money. This is because the three year rules always applied where the purchase of the replacement apartment occurs before the sale of the previous house. You therefore fail the three year test and are not able to reclaim the surcharge once the house is sold.

(b)  Apartment bought first but within the three years of you last living in the house.

The 3% surcharge will be due on the purchase of the apartment as by then there has been no disposal of the house.  However, if the disposal of the house happens within three years of the purchase, then a claim can be made to recover the 3% surcharge. See SDLTM09805 in HMRC’s Manual which says if the disposal happens before the date on the land transaction return for the purchase has to be submitted, then the surcharge does not have to be paid.

(c)  House sold at the same time or first, but apartment bought more than three years after the house was last lived in.

The surcharge would not have been due here because of the replacement of only or main residence exception had it been possible to complete the purchase by 26 November 2018 when the transitional provisions ended and the three year rules came in for this type of transaction.  However if the purchase of the apartment completes after 26 November 2018 the surcharge has to be paid because of the flat being retained and the three year conditions not being satisfied.

(d)  House sold at the same time or first, but apartment is bought within three years of having lived in the house.

The surcharge is not due because of the replacement of only or main residence exception.  There is only a month left though to get both transactions completed.

Scenario 5: Disposal of a major interest in the former home

Question

I went through a divorce which was finalised about six years ago. My former wife and I had owned the matrimonial home equally but, as part of the divorce process, I transferred part of my interest in it to her. I retain a one third share in the property which is unlikely to be sold for many years as it provides a home for her and the children. I had to move out and have been living in rented accommodation. I am now buying a small flat as my only residence, but have been told that I must pay the 3% surcharge as I retain an interest in the former matrimonial home worth more than £40,000. Is the surcharge due?

Answer for purchases completing before 22 November 2017

Although the examples given in the HMRC guidance for ‘replacement of only or main residence’ exception all refer to a sale of the whole of the previous house, the legislation refers to disposing of a “major interest” in it which HMRC says includes a share in a property. This is one area where the interpretation of the rules was unclear. As you have disposed of a share in the property, then you should be able to take advantage of the replacement of only or main residence exception so the 3% surcharge does not apply to your purchase.

HMRC were concerned as to “abuse” of those rules however and made changes for purchases completing from 22 November 2017.  It may be hard to persuade them even for purchases before 22 November 2017 that a disposal of part only of interest in a property is enough to operate the replacement exception.  The legislation was eventually further changed by the 29 October 2018 Budget to confirm that an undivided share is a major interest.  But that was only for purchases completing after that date.

This article is intended for general information purposes only and does not constitute legal or professional advice. Advice should be sought before proceeding with any transaction.

For Blake Morgan conveyancing clients, our SDLT experts are able to advise on complex property tax circumstances. Please contact our conveyancing solicitors if you have an enquiry.

This article was originally posted by John Shallcross on 3 January 2017 and was updated on 27 November 2018, on 5 August 2019 and on 20 January 2020.