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HMRC charge tax on the beneficial ownership of rental profit and capital growth from rental properties, HOWEVER, mortgage lenders take their security against legal ownership. It has been possible to split legal and beneficial ownership of property since the days of the Christian Crusades.
There are three primary tax reasons for creating a partnership by splitting beneficial ownership on rental properties using a Declaration of Trust:-
- To fully utilise more than one nil rate band and basic rate tax allowance
- To utilise more than one annual CGT personal allowance when selling property
- After a minimum of three years of submitting partnership tax returns a business partnership can be incorporated without SDLT becoming due (schedule 15 Finance Act 2003)
As the legal title at HM Land Registry does not need to be changed when transferring beneficial interests via a declaration of trust there is no requirement to advise or seek consent from mortgage providers. This is because their security remains unchanged. Thousands of Declarations of Trust are arranged by conveyancing solicitors every week.
Forming a partnership with a spouse is often considered most effective as transfers between spouses are exempt from Capital Gains Tax. However, if you’re not married there is nothing to stop you forming a partnership with another party. Examples include; a child, an unmarried ‘partner’, a sibling, a parent, a company (it could be your own company as companies are legal entities in their own right), another landlord or even a friend. If you transfer the optimal proportion of beneficial interest in your properties then CGT and Stamp Duty is often avoidable. Note that SDLT is only payable on transfers over £40,000 and that you also have an annual CGT exemption allowance to utilise. As of the Autumn Budget 2017 the additional 3% Stamp Duty rate is not applicable to transfers between spouses. Accordingly, spouses can transfer up to £125,000 between them without incurring CGT. Furthermore, the transfer value is calculated on the mortgage liability transferred between spouses and not the property value.
Once a Declaration of Trust has been established all beneficial owners of the property need to complete tax returns. If you operate your property rentals as a business it is also advisable to consider obtaining a Unique Tax Reference Number (“UTR”) from HMRC and to submit partnership tax returns just in case you ever decide to incorporate you rental property business partnership.
Using Up Lower Rate Tax Allowances
Finance costs restrictions as per The Finance (No. 2) Act 2015 will only result in increased tax becoming payable where the total of:-
- rental profit (as currently calculated for the 2017/18 tax year)
- plus mortgage interest
- plus other taxable income
…. exceeds £46,300 per person per annum (rising to £50,000 by the year 2020).
Profits and mortgage costs can be managed by transferring the beneficial ownership in property using a Declaration of Trust. The optimal split ensures both spouses utilise up to their full annual allowance as basic rate tax-payers. Once this is fully utilised it can make sense to form a Limited Company and register it as a member of a mixed partnership and possibly transfer some beneficial ownership to that too. To decide when to consider switching fully to a Limited Company status please see this linked article.
HMRC’s default position for taxation of rental income from jointly owned properties is that rental profit is split 50/50. This can be amended to any share (e.g. 99%/1%) subject to a Declaration of Trust and filing a Form 17 with HMRC within 60 days. Note that transfers to anybody other than a spouse could trigger Capital Gains Tax becoming payable.
Where property is owned by one person a Declaration of Trust can also be used to split the beneficial ownership. In that case Form 17 would not be applicable but HMRC would need to be informed of the arrangement and you would each need to complete tax returns for your share of rental profits in future years.