Property Partnerships: Taxation of General Joint Property
All partnership property is held jointly by its partners, but not all jointly-held property is in a property partnership. The following is an excerpt from our popular property tax report Property Partnerships which takes an in-depth look at the Taxation Of General Joint Property:
Here we shall consider the taxation aspects of property held in joint names, with joint beneficial interests. Aspects specific to property held jointly between spouses and civil partners are dealt with separately below, as are partnerships.
Income Tax and Joint Ownership
In the context of a joint property investment business, each joint owner is taxed according to his or her share of the net property income. PIM1030 states:
‘Where there is no partnership, the share of any profit or loss arising from jointly owned property will normally be the same as the share owned in the property being let. But joint owners can agree a different division of profits and losses and so occasionally the share of the profits or losses will be different from the share in the property. The share for tax purposes must be the same as the share actually agreed.’
So, by default, income will be allocated according to the underlying beneficial ownership of the property, but if there is an agreement in place that income be split differently, then that may be followed – and updated, from time to time. However, it is HMRC’s long-held position that an agreement cannot be applied retrospectively – i.e., it applies to the division of profits from the date of agreement, not to profits received beforehand.
It may be more tax-efficient if rental income is split other than according to underlying beneficial ownership and, particularly in family scenarios, one owner may be prepared to sacrifice some of his or her beneficial income entitlement so that a relative or close friend may receive more income (for matters specific to joint ownership between spouses and civil partners, please see next below).
This is generally referred to as a ‘settlement’ and there is specific legislation that treats the income ‘given away’ as still belonging to the ‘settlor’ (donor) for tax purposes. (ITTOIA 2005 Part 5 Chapter 5 s619 et seq.) However, the settlements legislation acts to treat the income given away as still belonging to the settlor only where the settlor does or may benefit. This is deemed automatically to be the case where the income is diverted to a spouse or civil partner, or to a minor child, but if the transfer is not to a spouse, etc., or minor child, there must be arrangements where the money can or will be paid or otherwise used to benefit the settlor (or the settlor’s spouse, minor children, etc).
In other words, spouses and young children aside, a ‘no-strings’ agreement to divert income from one party to another should not trigger the settlements anti-avoidance legislation. Furthermore, spouses are caught only where the thing transferred is essentially a right only to income – in other words, where one spouse transfers both the income and the underlying capital to the other spouse, then the settlements anti-avoidance legislation will not ‘bite’.
Example: Settlements Trap
Eric and Ernie are brothers and hold 50% each in their BTL portfolio. They also have other income sources and it suits the brothers to vary the income split from one year to the next, in advance (since HMRC says such agreements cannot apply retrospectively, as mentioned above). In March 2018, Eric agrees to split the income 40:60 in Ernie’s favour (say) for the foreseeable future. There are no arrangements whereby Ernie channels Eric’s 10% rental profits back to him, or Eric otherwise benefits from the diverted income (e.g. by the profits being channelled to Eric’s spouse).
Eric has‘settled’ some of his property income rights on Ernie, but the settlements anti-avoidance legislation will not apply because Eric cannot benefit from the income he has settled - he has not ‘retained an interest in the settled property’. Unless and until the profit share is revised, Eric will be taxed on 40% of the rental profits, and Ernie on 60%. Note, however, that in this simple example, Eric is still entitled to change his mind and demand 50% of the profits from some point in the future if he wants to – that is a fundamental aspect of his ‘beneficial ownership’ – and it is open to him to assert that right, should he wish to do so. In order to effect a permanent change, Eric would have to make an outright gift to Ernie of some of his beneficial interest in the underlying property (and that might have other tax implications, such as for Capital Gains Tax – see also 3.2 below).
Joint Ownership And Capital Gains Tax (CGT)
Basically, there are no special rules for joint ownership between parties, other than where those joint owners are spouses or civil partners, or in a partnership (for which see below).
Some readers may be surprised to learn that a gift can still be exposed to CGT, given that there are no proceeds with which to pay the tax. While it is true that there are forms of gift relief still available, they are quite narrowly targeted and, in general, HMRC wants its fair slice of CGT even if a taxpayer has been particularly generous and given the asset away for free or at a discount. This does not apply only between ‘connected parties’ such as between relatives but wherever there is an intention to confer gratuitous benefit on the donee. In other words, a ‘bad bargain’ is simply that, but where the vendor deliberately lowers the price for non-commercial reasons then the asset’s market value should be used instead of actual proceeds, if any, (see HMRC’s Capital Gains Manual at CG14530), even between complete strangers – although one might well ask why someone might want to make a gift, etc., to a complete stranger.
Example: Joint Ownership And Capital Gains Tax (CGT)
Eric from the above example decides to give a fifth of his 50% stake in the property business (i.e. 10% of the whole) to his brother Ernie, for no consideration. They bought the portfolio jointly at a cost of £1million and the portfolio is now estimated to be worth £2million, so a 10% stake would be worth c£200,000 (a professional valuation would be recommended, to adjust for any discount for joint holdings, etc.)
|Let’s assume that a correctly-applied part-disposal calculation brings us to the conveniently-round figures of|
Actual proceeds: £Nil
Market Value of proportion disposed of: £200,000
Cost attributable to proportion disposed of: £100,000Eric is therefore subject to a Capital Gain of £100,000, even though he has had no proceeds from Ernie to pay the CGT bill. While these rules are in point because they are brothers in the example and are therefore connected, the rules also apply wherever there is an element of gift – they would apply anyway, even if Eric and Ernie were not related.
Note that Ernie would be deemed to have acquired Eric’s 10% stake for the market value of £200,000, even though he actually paid nothing for it, because Eric has paid the CGT due on a deemed market value transfer for £200,000. It is a ‘win, win’ for Ernie.
Declaration Of Trust - Not Just a Piece of Paper
Many property investors assume that declarations of trust, where one party asserts to hold some part of the property for another’s benefit (i.e. beneficial interest), are simple and straight forward devices. And they are – but they can also have significant consequences because they can comprise a gift.
Example: Declaration Of Trust
James and Elizabeth are brother and sister and jointly hold a BTL property. Initially, the property is held in equal shares, but James wants to give Elizabeth a greater share in the property. He draws up a deed, which declares that a quarter of his share is held on trust for Elizabeth’s benefit. If drawn up and executed correctly, this will be effective, and from that point, income should by default be split 5:3 in Elizabeth’s favour, for Income Tax purposes.
But, what James may not realise is that he has also just given a quarter of his share in the property to Elizabeth for CGT purposes, as well as for income purposes, and that HMRC will want CGT due as if that share in that property had been sold for full market value. As James and Elizabeth are siblings, this gift would not escape CGT in the way that it might if they were spouses (see CGT Between Spouses below).
Depending on the precise wording of the deed, it may well constitute an outright gift of a share in the underlying property/ies, and have consequences for CGT, IHT, and SDLT, etc.
Joint Ownership And Stamp Duty Land Tax (SDLT)
SDLT is, of course, primarily charged on the consideration paid by the buyer. Lifetime gifts from one joint owner to another will therefore often escape a charge to SDLT. However, it should be noted that agreeing to take on responsibility for the mortgage debt will also rank as consideration for SDLT purposes.
Example: Joint Ownership And Stamp Duty Land Tax (SDLT)
James owns an investment property on his own but decides to give a half-interest to his long-term boyfriend, John. The property is worth £400,000 and has a £300,000 mortgage on it. John is obliged to take on part responsibility for the mortgage – deemed consideration (for the purposes of SDLT) of £150,0000. As this is currently John’s only property interest, (although he has previously owned his own home), he will be subject to SDLT as follows:
£125,000 @ 0% = £Nil
£25,000 @ 2% = £500
So, there will be a £500 SDLT charge as a consequence of the transfer; if John already held residential property interests then the SDLT charge would be £5,000 – a tenfold increase thanks to the extra 3% charge on acquiring an interest in additional residential property:
£125,000 @ 0%+3% = £3,750
£25,000 @ 2%+3% = £1,250
Most career landlords will already be well aware of the implications of the extra 3% SDLT charge introduced for ‘additional’ residential properties or dwellings. There is no direct benefit from buying investment property in joint names because the legislation introduced in FA 2016 requires that, if the 3% surcharge would apply to any one or more of the joint purchasers, then it will apply to the total consideration across all joint purchasers (FA2003 Sch 4ZA Para 2(3))
This is an excerpt from our popular tax report Property Partnerships.
Get the full report here: