Meg Saksida outlines issues that need to be considered when transferring property from partner to partner in a marriage or civil partnership.
When an investment property is held inside a marriage or civil partnership, it may be advantageous to split the ownership of the property between the couple rather than one individual owning and being taxed on all of it.
For income tax purposes, this may mean that one partner (inside the marriage or civil partnership) has no income or may be taxed in an income tax band lower than the other partner. It could be that the income from the property is sending one of the couple up to a higher tax band or causing them to have a child benefit tax charge.
For capital gains tax (CGT) purposes, one legal partner may have brought forward losses or have their annual exempt amount available. One of the couple may have losses in the year that they wish to offset against a gain or capacity in the basic rate band for a lower CGT rate.
Inheritance tax (IHT) benefits of transferring property include removing the property from the estate of the older taxpayer or ensuring that one of the couple has some of the main residence in their estate in order to benefit from the residence nil rate band.
Income tax: splitting income
To split income in an advantageous way, unless that advantageous way happens to be half-and-half, the property will need to be formally and legally split to be shared between the couple in the desired proportions. This is because a couple in a marriage or civil partnership who own a property jointly will always be taxed by HMRC on property income on the assumption that it is owned 50:50, irrespective of the actual ownership split.
If the couple own the property as ‘joint tenants’ in law, they will own it equally. But if they own it as ‘tenants in common’, they can own any percentage each that they wish.
To split the income in the desired proportion, the first step is to convert the property to be held as tenants in common (if it is not already). Once this split is made, the partners can transfer to each other the desired share of the property, ensuring the perfect distribution between them is made.
Within 60 days of its completion, an HMRC Form 17 will then need to be completed, notifying HMRC of the final split. This will formalise the new proportion of income received by the partners and the respective proportion of income taxed on the partners, from the date of the form’s completion.
Care needs to be made to ensure all the risks and rewards of ownership go with the gift of the part share of the property from partner to partner. The ‘settlements’ rules ensure that if the gift includes rights to income arising from assets, the asset transferred cannot simply be a right to the income only. It must be more than this, and in the case of a gift going from legal partner to legal partner of property, this means having all the risks and rewards of ownership and not just receiving the rental income. Practically, this will mean the donee partner being able to make decisions on their share of the property, paying the costs associated with their share such as insurance and agents’ fees, and there being no ‘strings’ or conditions attached to the transfer.
In the case commonly known as ‘Arctic Systems’ (Jones v Garnett [2007] UKHL 35), shares transferred to a wife were held not to be within the settlement rules as, in addition to the income, she had voting rights on the shares and the right to capital on a winding up. In the Trusts Settlements and Estates Manual (at TSEM4205), HMRC gives an example of Mr X, who transferred a rental property by an “outright gift” to his spouse Mrs Y, who then received the rental income. As Mrs X had “no further interest in or rights over the property”, the income was not subject to the settlements legislation.
As the couple’s situation and requirements change, the property may be transferred back to the donor partner at a later date, or it may be left to them in the donee’s will. As long as there are no artificial steps or series of transactions specifically created to produce a tax benefit, the Ramsay principle will not apply (the Ramsay principle follows the House of Lords case of the same name, where it was held that the substance and legal nature of a series of transactions should be regarded rather than any individual contrived steps).
Capital gains tax treatment
For CGT purposes, a transfer between legal partners who are living together results in a ‘no gain, no loss’ transfer. This means that the proceeds paid from the recipient partner to the disponer partner are deemed to be the same value as the historical cost of the original acquisition (including incidental costs of acquisition and enhancement expenditure). There is still a disposal for CGT purposes, but no gain or loss eventuates.
Interestingly, this transfer is no gain, no loss, irrespective of whether an amount is paid by the recipient partner. For example, if a wife transfers a painting to her husband that cost her £7,000 and her husband pays her £10,000 for it, for CGT purposes it will be a no gain, no loss transaction despite his proceeds. Furthermore, if he sells the asset in the future, his base cost for CGT will be £7,000, not £10,000.
If the couple separate, the no gain, no loss transfer currently applies until the end of the tax year of their separation. After this, they will be treated as connected parties until they divorce.
History of the property
If the transfer is a dwelling, the history of the legal partner who previously owned the property goes with the property to the new legal partner. This means that the donee partner’s period of ownership of the dwelling is the same as that of the donor partner, including eligibility to main residence relief. This is true even if that period started before the couple married or formed a civil partnership.
The effect is that the donee partner can count all periods where the residence was occupied as a main residence by their spouse as their own, which can be advantageous.
Inheritance tax position
Transfers from one legal partner to another are exempt from IHT. However, there is one coupling where this exemption is restricted, which is where a UK domiciled legal partner gifts to a non-UK domiciled legal partner. In these situations, the limit for gifting for the donor partner is £325,000. This is a lifetime limit and acts to limit all gifts to non-UK domiciled legal partners that the donor has, so even if one non-domiciled spouse dies or they divorce and the taxpayer has another non-domiciled spouse, this is not ‘refreshed’ every seven years like the normal nil rate band.
It might be thought that a gift of a property between legal partners is a gift in which the donor has reserved a benefit, as the donor's legal partner will be able to potentially benefit from the income or gain received by their legal partner. However, this is specifically stated as an exception in the IHT ‘gifts with reservation of benefit’ anti-avoidance provisions. In addition, due to the ‘related property’ rules and the ‘loss to donor’ rules required in valuing a transfer for IHT purposes, when making the transfer the property will still be considered when valuing the donor’s estate before and after the transfer, so the loss to the donor will be minimal, if any at all.
Practical tip
There are potentially many benefits in the taxing of income, gains and the death estate of splitting property in the ‘perfect’ ratio between spouses and civil partners. However, care needs to be taken that the split is made properly and does not attract any anti-avoidance legislation.
