Renting out part of your home - Beware of the potential Capital Gains Tax implications

When renting part of your main home such a Annexe or Self contained out-building it can trigger an unexpected tax bill

Renting out part of your home, such as a self-contained annexe, might seem like a smart way to generate extra income (which is subject to income tax), but many homeowners are unaware that doing so could reduce their entitlement to Private Residence Relief (PPR) when they come to sell the property—potentially leading to a unexpected Capital Gains Tax (CGT) liability.

What Is Private Residence Relief?

Private Residence Relief (PPR) is a valuable exemption from CGT on the sale of your main home. If you’ve lived in the property as your only or main residence for the entire period of ownership, any gain is exempt from CGT.

Renting Part of Your Home? Here’s the Catch

If you rent out part of your home—such as an annexe or converted basement—that area is no longer considered part of your private residence for PPR purposes, unless:

• The tenant is a lodger and shares living space with you (e.g. kitchen, bathroom).

• The let area is not fully self-contained (i.e. it doesn't have its own entrance, kitchen, and bathroom).

• You are not granting exclusive use of that part of the property.

  
  

When you grant exclusive possession of a self-contained section of your property to a tenant (like an annexe with its own entrance, bathroom, and kitchen), you effectively turn that section into a business asset. This portion won’t qualify for PPR, and when you sell, you may owe CGT on the part of the gain relating to that let area.

A Simple Example

Suppose you bought your property for £400,000, lived in it for 10 years, and sold it for £650,000. If the annexe (say, 20% of the total property) had been rented out for 5 of those 10 years, you’d lose PPR on half of the gain on that 20% portion:

• Total gain = £250,000

• 20% attributed to the annexe = £50,000

• 5/10 years rented out = 50% of the annexe’s gain = £25,000

• You could have to pay CGT on that £25,000 (Less any CGT annual exemption or other potential CGT reliefs).

Potential ways to Mitigate the Impact

With some simple planning the exposure to CGT can be reduced, such as

• Living in the annexe yourself before selling to re-establish PPR on that part.

• Limit the letting to short-term use without granting exclusive possession.

  
  

Final Thoughts

Renting out an annexe or any part of your home can be financially rewarding, but it's important to me aware of the potential CGT pitfalls and their mitigation, so it you are in this situation you should discus them with one of our Tax Team who can review you own specific circumstances to see how the rental could affect your Private Residence Relief and any future Capital Gains Tax liability.