Property rental, getting married and a tax trap
Getting married or becoming civil partners has many tax advantages. However, for landlords, it could result in higher income tax bills. Why, and what steps can you take to prevent this?
Income from jointly owned assets
A general principle of tax is that income derived by individuals who own an asset jointly is that they are taxed on any income the asset were produces in the same proportion. However, this needn’t be the case. For example, joint owners of a let property who are neither a married couple nor in a civil partnership together can allocate the rental income between each other regardless of how much of the property they own.
Example. Dev and Asmaa, who live together as a couple but are not married or civil partners, own a property 50/50 as joint tenants in common. Dev is only liable to basic rate tax on his income while Asmaa is liable to the higher rate. To reduce their joint income tax bill they draw up an agreement that says Asmaa is entitled to just 5% of the rental income and Dev, 95%. They will be taxed on the income they are entitled to even though they own the asset 50/50. If the annual income net of expenses was, say, £12,000, this arrangement would cut their joint tax bill by £1,080.
Dev and Asmaa could instead create a general partnership. This is a more formal arrangement that would also allow them to share profits (or losses) from year to year as they see fit.
While HMRC doesn’t like partnerships or profit-sharing agreements set up to gain a tax advantage, it accepts it can’t challenge them unless an arrangement is a sham. It’s important therefore that the terms of such an arrangement are properly evidenced.
Trap for attached couples
The rules are different for married couples and civil partners. If they own a property jointly, any income it generates is automatically taxed 50/50 regardless of who is entitled to the income and even if they own the property in uneven proportions, e.g. 75/25.
An income-sharing arrangement such as that used by Dev and Asmaa in our example will have no effect for tax purposes. Even though under the agreement they are entitled to 95% and 5% respectively, HMRC will tax them as if their entitlement was 50/50.
Problems with tax returns
If Dev and Asmaa from our example got married, their tax-saving plan would cease to work. They might not be aware of the trap and so continue to declare income in their tax returns on the 95/5 basis. As a result, Asmaa could find herself under investigation by HMRC.
To maintain tax efficiency, Asmaa could transfer part of her share of the property to Dev, say to bring his share to 95%. HMRC will then tax each of them on income in the corresponding proportions if the couple submits a joint election (a Form 17) to that effect. Alternatively, they could form a partnership which would allow them to allocate the property income how they wanted without the need to change the ownership shares.