Lee Sharpe considers the implications and in particular the traps to avoid when transferring property down to close family members.
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For more in depth discussion on this important area of property taxation, please see our new tax report ‘Passing Down The Property Portfolio’.
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Trap 1 - Stamp duty land tax: Gifts and debts
One of the main traps involving stamp duty land tax (SDLT) can be triggered when gifting property that is mortgaged. Essentially, SDLT is a charge on the consideration paid for property, so gifts from one person to another would not typically trigger an SDLT charge.
However, when the donee agrees to take on the burden of a mortgage, or even just part of it, SDLT law deems the donee’s assumption of that debt to be valuable consideration for the ‘gift’, akin to paying for the property itself.
SDLT law also says that no matter how much (or little) of the mortgage or debt the donee actually takes on, it is deemed to be in proportion to the donee’s share of the property acquired under the transfer.
Example 1: Helping out with the mortgage
Mr Frump owns a rental property worth £400,000 and subject to a mortgage of £150,000.
He gives half to Mrs Frump. They are a married couple, so the transfer is CGT-free (and typically IHT-free even if Mr Frump does not survive the gift by seven years). However, Mrs Frump agrees to indemnify Mr Frump in case he struggles with the mortgage.
In general law, her maximum exposure is £150,000 and falling, but that is not the deemed consideration for SDLT purposes; it is half the value of the debt, as she has received half the property, so just £75,000. Likewise, if the mortgage had been put into joint names, or Mrs Frump took over the entire mortgage.
Whether or not Mrs Frump is actually obliged to take on any responsibility for the mortgage is likely subject to Mr Frump’s mortgage contract, that may contain provisions protecting a lender’s interest.
This summarises an issue that is potentially important for property subject to SDLT. Readers with property in Scotland or Wales should take advice on the local equivalent land tax to check whether the principles still apply in the devolved nations.
Joint ownership and income tax
Joint ownership offers one or two possibilities where tax law accommodates general legal principles.
Example 2: Gift of property interest to daughter
Let’s say Mr Frump has another investment property that is worth £250,000 and yields £10,000 per annum in rental income. The property is mortgage-free; CGT exposure is nominal because it was inherited only a few years ago and has since had extensive work to remedy its previously dilapidated state.
Mr Frump does not need the capital wealth but does not feel he can comfortably forego all that rental income. So he gives 90% of the property to his adult daughter, Francesca.
Generally, Francesca is entitled to 90% of the rental income. Given that income tax law primarily follows such beneficial interest, HMRC would like to tax Francesca on £9,000 per annum. Let’s say that Francesca already earns £100,000 per annum and she does not want to lose £5,400 in additional income tax (as she also stands to start to forfeit her personal allowance, given her existing level of adjusted net income); and Mr Frump wants to maintain his income levels. So, he and Francesca agree to split the income £8,000:£2,000 in favour of Mr Frump.
As Francesca is entitled to £9,000 rental income, she has in effect ‘settled’ (i.e., given) £7,000 per annum to her father. HMRC is always happy to wheel out the ‘settlements’ (anti-avoidance) legislation that deems such settled or gifted income to be taxable on the original settlor – Francesca, in this case. Unfortunately for HMRC, Francesca is an adult, so the only way HMRC can apply the settlements regime is if HMRC can contend she still somehow benefits from the income she has given away. Given Mr Frump feels he needs the money, this would seem unlikely.
Example 3: Property portfolio put ‘in joint names’ with spouse
Special rules apply to settlements between spouses, so agreements to split income from investments ‘unevenly’ between spouses and civil partners may well risk falling foul of the settlements regime. But there are other treatments that can assist in the right circumstances.
Old Mr Murdoch was tempted, on the one hand, to give his property portfolio to his younger wife now, so that she might enjoy more annual income; but, on the other hand, he feared wasting the CGT-free uplift she might potentially enjoy if he left the properties to her via his will, instead.
Mr Murdoch decides to put the portfolio in joint names with Mrs Murdoch, but (unlike Mr Frump) gives only (say) 10% of the equitable interest in the portfolio to his wife, keeping the rest of his £10m portfolio for now, to be transferred to her on his death. So only 10% of that portfolio will not now benefit from the CGT-free uplift on death, while the remaining 90% will (or, at least, should not automatically be so exposed).
Meanwhile, income tax law states income from property held in joint names between spouses or civil partners is automatically taxed as if split 50:50 even if not so held in equity (that default approach applies unless and until the couple jointly notify HMRC to apply income tax precisely according to their respective underlying equitable interests – which Mr and Mrs Murdoch choose not to do).
So, Mrs Murdoch will then automatically be taxed on half of the property portfolio income, regardless of how much income she actually receives. This should improve the couple’s overall annual income tax efficiency while changing little on the ground. Assuming Mrs Murdoch is not obliged to shoulder any debt burden along with the properties, SDLT should not apply either.
Trap 2 – Settlements anti-avoidance legislation
The scope of the settlements regime is narrower than HMRC would care to admit, but it does require careful consideration to ensure that any arrangements work as intended.
This is particularly the case when dividing income between spouses and civil partners (or in scenarios involving young children).
Trap 3 – Giving things away while continuing to use them
So far, we have covered the idea of giving assets away outright, and putting investment property into joint ownership so that some of the underlying capital wealth can (or may eventually) flow through to the next generation relatively tax-efficiently. Individuals have long tried to reduce their IHT exposure by giving assets away while retaining some right to use or occupy that property – most often, the family home.
There are two strands of anti-avoidance legislation meant to combat this:
1. Gifts with reservation of benefit – Typically, this IHT anti-avoidance provision applies where (say) I have given my home away to my children but retained the right to occupy the property as if it were still my own home. IHT law decrees that such gift with reservation of benefit (GROB) assets have never left my estate and will be chargeable to IHT on my death (this simplifies complex provisions that actually give HMRC more than one taxing opportunity).
2. Pre-owned assets tax – I am clever enough to give an asset away in my lifetime but make some sort of arrangement that manages to circumvent the GROB rules, while I still get to benefit from the asset that I formerly owned. I may then be subject to an annual income tax charge, which basically aims to tax me on the ‘rental value’ of that property I am still using.
Conclusion
I have looked at one or two simple approaches that may give landlords opportunities to transfer personally owned property relatively tax-efficiently. I have also highlighted some of the main traps that careful planning should help to avoid. Next, I shall focus on property held in a company.
