Sarah Bradford explores some tax implications of owning property with your spouse or civil partners.
When a couple are looking to invest in property, they will often own the investment property jointly. Where a buy-to-let property is owned jointly, the tax implications depend on the relationship between the parties. If the joint owners are married or in a civil partnership, there are special rules to be aware of.
Unmarried couples
Unmarried couples are not subject to the rules that apply to married couples and civil partners. This can provide more flexibility as to how rental profits from a buy-to-let are taxed. As a general rule, the income is allocated between the joint owners in accordance with their ownership shares. This may or may not provide the best result for tax purposes.
If a different allocation would lead to a lower combined tax bill, the joint owners can simply agree between themselves to split the rental profits in a different way; no formal election is required and, unlike married couples and civil partners, unmarried joint owners have the flexibility to split the income in any way they choose. However, the split for tax purposes must be the same as the profit share actually agreed.
Example 1: Unmarried landlords
Olly and Lucy buy an investment property together, which they let out. Olly owns 40% of the property and Lucy owns 60% of it. The rental profits are £10,000 a year.
This is allocated in accordance with their ownership shares, so that Lucy is taxed on rental profits of £6,000 a year and Olly is taxed on rental profits of £4,000 a year.
Whether this is tax-efficient or not depends on the rates at which they pay tax.
If they pay tax at the same rate, the tax on the rental income will be the same regardless of who pays it, and there is nothing to be saved taxwise by allocating the rental profits in a different way; the default position provides the optimal split.
However, if they pay tax at different marginal rates, it is more tax-efficient for the person paying tax at the lowest marginal rate to be taxed on a greater share of the income. If Olly had no other income and Lucy was a higher rate taxpayer, it would make sense for them to agree for Olly to receive all the rental income. As this would be sheltered by his personal allowance, there would be no tax to pay. By contrast, if they shared profits in accordance with their ownership shares, Lucy would pay tax of £2,400 on her £6,000 share of the profits. By agreeing a different split, the couple can save tax of £2,400.
Unmarried couples should review the income split of any jointly-owned profits and consider whether allocating rental profits differently would save them tax.
Married couples and civil partners
Different rules apply to determine the income allocation where the joint owners are married or in a civil partnership. These afford less flexibility when it comes to choosing the most efficient allocation of income as they cannot simply agree between themselves to share the income in such a way as to minimise their combined tax bill.
Default position
Regardless of the actual ownership shares, income arising from property jointly owned by spouses (or civil partners) is treated as arising to them in equal shares. If the couple do nothing to change this, each partner will be taxed on 50% of the rental profits from their jointly-owned property.
Example 2: Married landlords
Hamish and Hannah are married. They own a buy-to-let property, in which Hamish has an 80% share and Hannah has a 20% share.
The rental income from the property is £12,000 a year.
Despite the fact they own the property in unequal shares, each spouse is treated for tax purposes as if they had received rental income of £6,000.
The deemed 50:50 split may be advantageous, or it may not. Again, it depends on the rate at which each individual pays tax.
Example 3: Different tax rates (1)
The facts are as in Example 2. Assume that Hamish pays tax at 40% and Hannah pays tax at 20%.
Where the default position applies, each person is taxed on income of £6,000. Hamish will pay tax of £2,400 on his share and Hannah will pay tax of £1,200 on her share.
Hamish owns 80% of the property but only pays tax on 50% of the income. As Hannah pays tax at a lower rate than Hamish, the default split effectively moves income from the 40% rate to the 20% rate, saving tax in the process.
Form 17 election
Where the default split does not produce the best result from a tax perspective, if (and only if) the property is owned in unequal shares as tenant-in-common, the couple can elect (on Form 17) for the rental income to be allocated for tax purposes in accordance with their underlying beneficial ownership shares.
The way in which the property is owned is crucial here; a Form 17 election can only be made where the spouses or civil partners own the let property as tenants-in-common. Under this form of ownership, each person owns a share of the property individually. By contrast, a Form 17 election is not possible if the property is owned as joint tenants; where this is the case, both parties jointly own the whole property and rental income can only ever be shared 50:50.
Form 17 can be found on the Gov.uk website (tinyurl.com/HMRC-Form17-Election).
Where a Form 17 election is made, it must reach HMRC within 60 days of the date of the last signature for it to be valid. The election will not apply if it is received by HMRC outside this timescale. Income is treated as arising in accordance with the underlying beneficial ownership from the date of the Form 17 election; income received prior to the date of the election is treated as arising equally. Thus, if a couple wish for the rental income for the tax year to be allocated in accordance with the actual ownership of the property, the election must be made at the start of the tax year. If it is not made until the end of the tax year, it will not achieve its desired effect.
The timing rules means that it is not possible to wait until after the end of the tax year and see what income each party has received and then decide whether the election would be beneficial or not. This could be problematic if income is uncertain and it is not possible to know in advance whether the election will be beneficial; as the Covid-19 pandemic has shown, what actually happens may be very different from what one expects to happen. A Form 17 election cannot apply retrospectively.
It should also be noted that a Form 17 election cannot be made in relation to furnished holiday lettings. Instead, separate, more beneficial, rules apply which allow the income to be allocated in whatever proportion the owners choose.
Example 4: Different tax rates (2)
Assume the facts are as in Example 2 and Example 3, except that Hannah is a higher rate taxpayer and Hamish is a basic rate taxpayer.
In this situation, it would be beneficial to make a Form 17 election, as this will allow 80% of the income to be taxed at the basic rate and 20% at the higher rate, rather than 50% at the basic rate and 50% at the higher rate.
If the facts are as in Example 1 and Example 2, and Hamish is a higher rate taxpayer and Hannah is a basic rate taxpayer, a Form 17 election would not be beneficial; less tax is payable if the income is treated as arising equally.
Changing the ownership split
Although the income arising from property owned by married couples and civil partners as joint tenants can only be split 50:50 or in accordance with the actual beneficial ownership, a different split can be achieved by taking advantage of the capital gains tax ‘no gain, no loss’ rules to transfer shares in the property from one partner to the other without triggering a capital gains tax bill.
While there will be some costs attached (including possibly stamp duty land tax), depending on the tax at stake, it may be worthwhile.
Planning tips
Married couples or civil partners looking to buy a buy-to-let property should take the income tax implications into account when deciding whether to own the property jointly, and in what shares. Before the start of each tax year, they should consider whether a Form 17 election would be worthwhile in relation to any jointly-owned property, where applicable.
