Reduce Property Gains Tax, Property Investors

Deed of trust

simon

Simon Misiewicz

25th July 2016

What is a deed of trust?

A deed of trust is a legally-binding document that dictates the capital and revenue interests in a property.

There were a record number of buy to let UK landlords setting up companies for their property investments in 2020, with buy to let businesses being the second-highest company type incorporated after firms selling goods online.

More UK landlords set up buy to let companies between 2016-2020 than in the whole of the 50-year period preceding. By the end of December 2020, there was a record 228,743 buy to let companies in the UK. Of these new property investment companies, 34% were based in London.

A deed of trust can be used to transfer property income gained to reduce the amount of tax paid to HMRC.

At a time when more UK landlords are setting up buy to let businesses than in the last 50 years, tax-efficient tools such as a deed of trust can make a significant difference to a property investor’s tax bill.

As leading property accountants, we work with over 1,000 retained buy to let UK landlords, helping them to run more tax-efficient property businesses and to lower the tax paid from their rental incomes.

Are you married or in a civil partnership? Do you own property investments between you? Is one person a higher rate taxpayer and the other a basic rate taxpayer?

You may already be aware that you could reduce your tax liability by splitting your property profits favouring the lower rate taxpayer. Did you know that HMRC will always assume spouses own a 50/50 share in all property unless they are told otherwise?

Typically couples own property as “joint tenants”, which means that the property is owned 50%/50%. The other way to own property is as “tenants in common”, which specifies a different split in ownership and profits, meaning one person can have 99% of the income and the other person receives just 1%.

If one of you is a basic rate taxpayer, it is worth considering who will receive rental income for tax purposes and changing the beneficial ownership of buy to let properties in your portfolio to reflect this.

Putting a deed of trust in place effectively diverts the income on a property from the legal owner to the person named on the deed of trust. This transfer of interest can be beneficial as a tax-saving strategy for UK landlords.

The HRMC differentiates between the ‘legal’ and ‘beneficial ownership of a buy to let property. The legal ownership of a property is whoever the owner is according to the Land Registry, and if a property is mortgaged, who the mortgagee is.

It is, however, the beneficial owner of a property that HMRC taxes on property income. A deed of trust allows the legal and beneficial ownership of a property to be detached from one another.

This means that although the legal title of a property can be owned by one or both spouses or both people in a civil partnership, the beneficial interests (the right to receive income from the property) are held by the person who then declares the income on their tax return.

A spouse or civil partner is often the recipient of property income from a deed of trust since capital gains tax is not payable on spousal transfers of property. Alternatively, trusted siblings, family members and friends or business partners can all be recipients.

The overall objective is to move property income into the name of a person who is unaffected by Section 24 legislation and subsequent tax liability.

Please note that the deed of trust is a legal document. The deed of trust is, therefore, legally binding. Many solicitors will also update the land registry to show the public that there has been a change of legal ownership. The change will also affect how assets are passed on after death. Make sure you speak with a solicitor about this.

Where buy to let property is mortgaged, further professional advice may be necessary. A transfer of the beneficial interest may breach the terms of the mortgage with the lender. A transfer of an interest in land could also trigger an SDLT liability if the sum outstanding is over £125,000.

You may be interested in our main article ‘buy to let tax for UK landlords’. This article discusses all the different tax types that you need to be aware of as a UK landlord.

If you wish to know the basics of Capital Gains Tax and annual CGT allowances, be sure to read this article first.  If you wish to reduce the amount of Capital Gains Tax you might pay, then please look for advice here.

What are the benefits of a deed of trust?

Reducing property profits using a deed of trust and form 17

Splitting property profits 50/50 has a negative tax implication on couples where one partner is a higher rate taxpayer and one a basic rate taxpayer. They could pay less tax overall if all of the property income was included in the lower taxpayer’s income.

A deed of trust is a way of making this happen. It is a legal document drafted by a solicitor that allows you to alter the shares in a property. So a lower taxpaying spouse can be classed as the one benefiting from the rental income.

Using a deed of trust to transfer beneficial interest in a buy to let property investment from one person to another can be a tax-efficient way to reduce the impact of Section 24 legislation in effect from 2016, or to mitigate the impact of high rate income tax on rental profits from a property business.

As highlighted later in this article, however, there are CGT and SDLT considerations to be taken into account. The relevant documentation (a deed of trust and form 17) must be drawn up and where appropriate filed with HMRC.

Reducing Capital Gains tax using a deed of trust and form 17

If you are selling a property then you may be liable to Capital Gains Tax (CGT). Each person receives an annual CGT allowance of £12,300 before any tax is paid. If a couple own a property and it is sold then the first £24,600 is tax-free. After that, the gain is taxed on the investment property at 18% for basic rate taxpayers and 28% for high rate taxpayers.

A deed of trust may also be used to minimise CGT liabilities as you can utilise one another’s CGT annual allowances. Not only that but if done correctly you can also identify the right % allocation to maximise the basic rate tax band for CGT purposes.

This is more significant if you are married and the property is in one person’s name.

We have helped hundreds of UK property investors to minimise the impact of CGT using a deed of trust.

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So, what is new?

It was not until my tax team spoke about this at length with HMRC that we discovered the deed of trust and form 17 need to be accompanied for:

– Properties already purchased in joint names
– Properties couples buy in future under a ‘tenants in common’ structure where ownership is not 50/50

This means that every property owned by a couple will be deemed to be owned 50/50 unless you tell HMRC otherwise. Even if you buy a property as tenants in common with a split of 99/1 in favour of the lower rate taxpayer.

Apportioning the profits, in the same way, could mean there is a potential risk that your self-assessment return may be challenged. This is because although you correctly bought the property, you failed to notify HMRC via form 17.

If the couple divorce then the assets will remain 50/50 until the divorce settlement has been finalised.

What solicitors can get wrong and do not tell you about regarding deeds of trust

Here are some of the issues that our clients have found when using solicitors to prepare a deed of trust, and our experience of correcting the mistakes:

– Solicitors may use templates and do not check them thoroughly. As a result, the names of the individuals or the name of the property is incorrect, voiding the whole document.
– They may not tell you that an HMRC form 17 declaration of income is required to ensure that property income can be reallocated. HMRC do not care that a deed of trust is done. If this is not done, the document becomes void and you have to start the whole process again.

Include your form 17

You could ask your solicitor to do the work. Unwittingly you leave the office thinking that everything has been sorted. Sadly, HMRC can investigate the past six years’ worth of accounts. They can backtrack and unravel all your work.

They can put the property income back to the high-rate taxpayer if they find you have re-allocated property income based on a deed of trust without the submission of the required form 17 declaration of income.

Deeds of trust heartache

What amount of tax would you have to pay back if you have done a deed of trust without a form 17? How much heartache and administration would be caused as a result of the solicitor’s work?

The fact is that solicitors cannot be held responsible. They have done what was requested and that was to create a legal document called a deed of trust. The fact that they did not tell you or you did not know that an HMRC form 17 declaration of income was needed to be completed is not deemed to be their fault.

Stamp Duty Land Tax (SDLT) consequences of a deed of trust

The beneficiary transfer of a property from one spouse to another does not give rise to SDLT. This is because a gift from one spouse to another is a nil gain and nil loss. As such a beneficiary of interest transfer is not subject to SDLT nor Capital Gains Tax (CGT). We must remember that SDLT is only chargeable if there is deemed consideration. Consideration may be in the form of cash, asset swaps or a mortgage.

Typically we see clients that are requested by their bank to add their spouse onto the mortgage when transferring a beneficiary entitlement to their spouse. This is deemed consideration and would be subject to SDLT on their share of the mortgage.

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3% SDLT higher rate consequences of a deed of trust

Please note that the 3% SDLT charge does not apply to these transactions as highlighted by HMRC’s manual (example 3).

“Husband wishes to transfer half of his only residential property worth £300,000 into his wife’s name. No cash changes hands but the property is subject to a mortgage for £200,000. His wife has previously owned property but not at the time of the transfer.

As half of the property is being transferred, half of the mortgage debt is being taken over by the wife.

There is no SDLT due on this £100,000 chargeable consideration as it does not exceed the tax threshold but the transaction is still notifiable. N.B. First Time Buyers relief and Higher Rates for Additional Dwellings do not apply to this transaction.

Therefore the 3% SDLT higher rate does not apply when transferring an asset between spouses even if the mortgage liability changes from one person to another

Capital Gains Tax when going through separation or divorce

There are special rules that apply when you are going through separation or divorce. You benefit from Capital Gains Tax (CGT) exemption if you transfer assets whilst you are married. This means there are no CGT liabilities when transferring assets between husband and wife or civil partners.

However, you may have to pay CGT if you separate or divorce and then transfer assets between you. It is important to get advice from a CGT tax specialist before you separate.

Other considerations when transferring the beneficiary entitlement from one spouse to another

It is worth noting that if only one person is on the mortgage and they die their spouse would need to apply for a mortgage to take it over. This could cause issues if they are not deemed mortgageable without their spouses’ income.

This requires you to speak with your mortgage broker and solicitor. Talk to them about their tax tips.

See what implications they can identify and solve. You may decide to add your spouse to the mortgage and pay the SDLT. The spouse added to the mortgage will also become legally responsible for their share of the mortgage repayments.

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