Jointly Owned Property – The Best Of Both Worlds!

Sarah Bradford explores how to achieve the optimum result in respect of property owned jointly by spouses or civil partners for both income tax and capital gains tax purposes.

Where a rental property is owned jointly by spouses or civil partners, the ownership split that delivers the best result for income tax purposes will not necessarily be that which gives the best result for capital gains tax purposes. However, it is possible to have the best of both worlds.

Where a rental property is owned jointly by a married couple or by civil partners, the extent to which each spouse or civil partner is taxed on the rental income depends on the underlying ownership of the property, and whether a Form 17 (‘Declaration of beneficial ownership in joint property’) has been filed with HMRC.

In the absence of a Form 17 declaration, the default position is that rental income is taxed equally on each spouse or partner, regardless of the underlying ownership of the property. Depending on the circumstances, this can be a good or a bad thing, as the following example illustrates.

Dave and Lisa are married and own a property jointly. Actual beneficial ownership of the property is split 99% to Dave and 1% to Lisa.  In 2014/15, they make a rental profit of £15,000 from letting out the property. They have not made a Form 17 declaration.

Dave is a basic rate taxpayer and Lisa is an additional rate taxpayer. The default position applies and they are each taxed on 50% of the rental profit. Consequently, Dave pays tax of £1,500 on his share (£7,500 @ 20%), whereas Lisa pays tax of £3,375 on her share (£7,500 @ 45%). Their combined tax bill in respect of the rental income is £4,875 (£3,375 + £1,500).

In this case a 50:50 split does not achieve the best result, as a lower tax bill could be achieved if the rental income was taxed in accordance with actual ownership.

Ian and Caroline are also married and jointly own a property. Actual beneficial ownership of the property is 99% to Ian and 1% to Caroline. Ian is a higher rate taxpayer and Caroline has no income.

In 2014/15, rental income amounts to £18,000. They have not made a form 17 declaration.

As no form 17 has been filed, the default position applies and they are each taxed on 50% (£9,000) of the rental income. Ian pays £3,600 (£9,000 @ 40%) and Caroline pays no tax on her share as it is covered by her personal allowance for the year of £10,000.

In this case the default position delivers a better result than if they were taxed in accordance to their actual beneficial shares.

Nigel and Adam are in a civil partnership and jointly own a rental property in equal shares. In 2014/15, they achieve a rental profit of £10,000. Nigel is a higher rate taxpayer and Adam is a basic rate taxpayer. 

They are each taxed on 50% of the rental profit. Nigel pays tax of £2,000 (£5,000 @ 40%) on his share and Adam pays tax of £1,000 (£5,000 @ 20%) on his share.

In this case, the default position mirrors actual beneficial ownership. However, tax could be saved if Adam owned more of the property and the couple were taxed in relation to their actual ownership.

If the property is owned equally or a 50:50 split gives a better result than being taxed in relation to actual shares, a Form 17 declaration should not be made.

If a property is solely owned by a higher or additional rate taxpayer, transferring a 1% share to a spouse or civil partner paying tax at a lower rate will move 50% of the rental income to that lower rate taxpayer.

The default 50:50 split does not apply where property is not owned equally and the couple make a declaration on Form 17 for income from the property to be taxed in accordance with their actual shares.

Form 17 is available on the HMRC website (www.hmrc.gov.uk/forms/form17.pdf).

You can only elect to be taxed in proportion to actual shares, not according to the split that gives the best result.

In Example 1, if Dave and Lisa were to complete a Form 17 declaration, Dave would be taxed on 99% of the rental profit (£14,850) and Lisa on 1% (£150). This would increase the tax payable by Dave to £2,970 (£14,850 @ 20%) and reduce the tax payable by Lisa to £67.50 (£150 @ 45%). 

However, as a result of making the form 17 declaration their total tax bill is reduced from £4,875 to £3,037.50. By electing to have the rental income taxed in relation to their actual shares, they have achieved an overall tax saving of £1,837.50.

However, there would be no benefit in Ian and Caroline (see Example 2) making a Form 17 declaration. Ian is a higher rate taxpayer and owns 99% of the property, but is only taxed on 50% of the income. The remaining 49% pertaining to his actual share is attributed to Caroline, and as she is a non-taxpayer it is received free of tax. Making a Form 17 declaration would move this 49% share (£8,820, being 49% of £18,000) from being received tax-free to being taxed at 40%. This would increase their combined tax bill by £3,528 (£8,820 @ 40%).

Nigel and Adam (see Example 3) own the property equally and the default position already taxes them in accordance with their actual shares, so there is nothing to be gained in making a form 17 declaration.

As seen above, there are two possible splits when it comes to taxing rental income from property owned jointly by spouses and civil partners:

It may be that neither of these produce the best result.

This can be illustrated by looking at the case of Ian and Caroline in Example 2. As Caroline does not have other income in 2014/15, the lowest combined tax bill would be achieved if Caroline was taxed on all the rental income. 

However, given the current beneficial ownership, the best result that can be obtained is via the default 50:50 split. But if Ian were to transfer his entire share in the property so that Caroline becomes the sole owner, the first £10,000 would be covered by her personal allowance and the remaining £8,000 would be taxed at the basic rate of 20%. This would reduce the combined tax bill to £1,600 (£8,000 @ 20%) – a saving of £2,000. As transfers between spouses are at a value for capital gains tax that gives rise to neither a gain nor a loss, the property could be transferred into Caroline’s sole name without triggering a capital gains tax liability. 

Similarly in Example 1 and Example 3, the tax bill in respect of the rental income could be reduced by transferring the property into the sole name of the individual with the lowest marginal rates of tax.

However, there may be non-tax reasons for not changing actual beneficial ownership and these should be taken into consideration.

A good result for capital gains tax purposes

What delivers the best result for income tax purposes may not deliver the best result for capital gains tax purposes. However, the ability to transfer property between spouses for an amount that delivers neither a gain nor a loss means that it is possible to have the best of both worlds. This can be illustrated by way of an example, once again looking at the position of Ian and Caroline from Example 2.

Having taken advice, Caroline and Ian transfer the rental property into Caroline’s sole name to reduce the tax payable on the rental property. They later decide to sell the property and estimate that they will realise a gain of £20,000.  Assuming a capital gains tax annual exemption of £11,000 (at the 2014/15 amount), as things stand, Caroline would realise a chargeable gain of £9,000 and pay capital gains tax of £1,620 (£9,000 @ 18%).

However, assuming that Ian still has his capital gains tax exempt amount of £11,000 available, by transferring 50% ownership in the property to him prior to sale, both Ian and Caroline will realise a gain of £10,000. In each case, the gain is fully covered by the annual exempt amount, with the result that no capital gains tax is payable.

Thus review the actual beneficial ownership prior to sale in light of capital gains tax exempt amount available to each partner, and adjust the ownership prior to sale by taking advantage of the no gain/no loss rule for transfers between spouses and civil partners. 

By changing the actual beneficial ownership according to the circumstances, it is possible to have the best of both worlds.