We’re in this Together! (Part 2) – Shared Ownership
Having established in Part 1 of this series that the taxman is primarily interested in who is the “beneficial” owner, we shall now look at how that ownership may be shared. We shall also look at whether or not a joint investment in a property rental business constitutes a partnership, and what this means for tax.
1. Joint ownership
Where two or more parties own an asset, they may do so as ‘joint tenants’ or ‘tenants in common’.
These two legal phrases are very important. While many readers will be experienced property owners and quite familiar with their meaning, we did promise to cover the basics, so here goes:
Firstly, “tenancy” in this context has nothing to do with whoever happens to be renting the property. It is about ownership (blame solicitors for using the word ‘tenants’ to describe ownership!).
Joint tenants - each have an equal right to enjoy the whole of the property.
Tenants in common - each hold a distinct share in the property, which can be unequal.
Here’s an analogy – although I’d be the first to admit it has limitations:
Example – Anyone for chocolate cake?
Jane and Fred both like chocolate cake. They club together to buy a particularly nice chocolate cake. Clearly, they now jointly own a chocolate cake.
If they own it as joint tenants, they are not allowed to cut it in half and take the half away for themselves, or anyone else. They have to sit down and admire it together, as neither Jane nor Fred ‘owns’ a particular slice. They had better also have similar appetites, because they must eat exactly half each.
Interestingly, if one of them dies while admiring the cake (diet perhaps being a factor), then the other stands to inherit the whole cake.
If they instead own the cake as tenants in common, then Fred could carve out his own share of the cake for himself (which could be unequal, for instance if he put up most of the funds), and perhaps share some of his part with friends or family, because it’s his slice to deal with as he sees fit.
If Fred’s lifelong addiction to chocolate cake gets the better of him, Fred can bequeath his share to whomever he wants, although this can include Jane if he likes - but as a tenant in common, Jane has no automatic right to keep all of the cake if Fred dies, unlike with a Joint Tenancy.
Trap:
In terms of property ownership, the ‘default’ arrangement is as joint tenants. Given the restrictions of joint tenancy – in particular on inheritance and potentially divorce – this frequently turns out to be a nasty surprise. Note that the rights of the surviving party to a joint tenancy have the power to over-ride someone’s Will even if the Will explicitly leaves the deceased’s share to someone else.
Tenants in common – Strict legal position
According to the law in England and Wales, land cannot strictly be held as tenants in common but will instead be held on a ‘trust for sale’ – effectively a bare trust on behalf of the owners. As a bare trust is transparent for tax purposes, it follows that despite the legal niceties, the owners can effectively be tenants in common for tax purposes, and this is how HMRC treats it. See for instance HMRC’s Capital Gains manual (www.hmrc.gov.uk/manuals/cgmanual/CG70504.htm).
Can the ownership be changed?
In the absence of provisions that ‘make’ joint ownership into a tenancy in common, there will be a joint tenancy.
But this is relatively easy to change if the owners acquire as joint tenants and later realise that they would prefer to be tenants in common.
There are various ‘methods’ to convert a joint tenancy to a tenancy in common. The normal approach is to ‘sever’ a joint tenancy using a notice of severance, which can in theory be very straightforward (although we recommend legal advice always be sought to ensure the notice is effective):
“I, Fred, give notice to Jane of my intention to sever the Joint Tenancy of No. 1, Chocolate Street. 1 August 2013.”
This would then result in Fred and Jane becoming equal tenants in common. If Fred had put up most of the funds to buy the property, then the notice of severance could incorporate the unequal beneficial interest, say 75%, in favour of Fred.
Note that Fred does NOT need Jane to co-sign the notice of severance, although the joint tenants can collectively sign to the effect that they want to convert to a tenancy in common, as an alternative to a notice of severance.
A joint tenancy could also convert to a tenancy in common if (say) Fred were to become bankrupt – although a notice of severance would be rather less painful.
Will it cost any tax to change to tenants in common?
A mere conversion of joint tenancy to tenancy in common is not normally a disposal of one’s underlying beneficial interest in the property, in which case capital gains tax is not in point.
If unusually the underlying beneficial interest does change in the process, then whoever has reduced his or her interest in the land will be treated as having made a potentially chargeable disposal for capital gains tax purposes – see www.hmrc.gov.uk/manuals/cgmanual/CG70525.htm.
2. Are we partners or joint investors?
It is common for people to talk about a ‘property partnership’ or that they are ‘partners’ in a property investment business.
In fact, most property ‘partnerships’ are not partnerships at all, but simply joint investments. This is relevant for tax purposes, as there are special tax rules for partnerships which do not apply to joint investments.
A partnership is also treated as a separate entity for tax administration, with its own tax file and annual tax return. These are not normally relevant for property investors.
Passive investment business or trade?
Part of the confusion arises because for tax purposes, a property rental investment is taxed on the same basis as a trading business, drawing up accounts and calculating profits in broadly the same way. And two or more people carrying on a trade together are normally treated as being in partnership.
But it is very rare for a mainstream property rental business to amount to a trade, although hotels and property developers will generally be considered to be trading.
Does it really matter?
HMRC is quite keen to stop joint property businesses being treated as partnerships. One of the underlying reasons for this is arguably that the existence of a partnership could be an important milestone for claiming that a rental business amounts to a trade, since a partnership indicates a degree of organisation and activity above and beyond the mere holding of property and passive receipt of rental income. As trades are eligible for special tax reliefs for losses – and, critically for property businesses, entrepreneurs’ relief for capital gains – it is perhaps understandable that HMRC resists a claim to partnership status. And to be fair to HMRC, the Partnership Act 1890 explicitly states that jointly held property does not of itself give rise to a partnership. HMRC’s position is set out more fully in their Property Income manual at PIM1030 (www.hmrc.gov.uk/manuals/pimmanual/PIM1030.htm).
Trap:
If in the relatively unusual case that a property investment partnership does exist, beware that losses from property held as a partner, cannot be pooled against ordinary letting profits, etc., as a joint investor – or vice versa.
Practical Tip:
The distinction between ownership as joint tenants and as tenants in common is very important and generally easy to “fix” – but it pays to be pro-active.
