Many married couples and civil partners own rental properties together. Where one spouse pays tax at a higher rate than the other, it is common to ask whether rental income can be allocated differently to reduce the family’s overall tax liability.

Whilst this is often possible, it is not simply a case of choosing how rental income is divided. The tax treatment depends on the beneficial ownership of the property, and any changes to ownership can have wider implications for Income Tax, Stamp Duty Land Tax (SDLT), Capital Gains Tax (CGT) and estate planning.

This article explains the rules and highlights the issues that should be considered before making any changes.

The Default 50:50 Rule

The starting point is Section 836 of the Income Tax Act 2007. Where a property is jointly owned by spouses or civil partners who are living together, HMRC will generally treat the rental income as arising equally between them for Income Tax purposes.

This means that each spouse is taxed on 50% of the rental income, regardless of their actual entitlement to the property or the rental profits.

For example, if a husband and wife jointly own a buy-to-let property generating annual rental profits of £20,000, HMRC will normally assess £10,000 on each spouse, even if one spouse contributed substantially more towards the purchase.

Why Consider a Different Income Split?

The default 50:50 treatment is not always tax efficient.

Common situations where a different allocation may be beneficial include:

• One spouse is a higher-rate or additional-rate taxpayer whilst the other pays tax at the basic rate.
• One spouse has unused Personal Allowance available.
• The couple wishes to preserve entitlement to the Personal Allowance by keeping income below £100,000.
• The family wishes to maximise after-tax rental profits.

In these circumstances, it may be advantageous for more of the rental income to be taxed on the spouse with the lower marginal tax rate.

Beneficial Ownership and Declarations of Trust

Before considering the tax position, it is important to understand the difference between legal ownership and beneficial ownership.

Legal ownership refers to the names shown on the title deeds and Land Registry records.

Beneficial ownership refers to the underlying economic ownership of the property. It determines who is entitled to rental income, sale proceeds and any increase in value.

Where spouses wish to own a property in unequal shares, a Declaration of Trust is commonly used to document the arrangement.

A Declaration of Trust is a legal document that records the beneficial ownership of a property and can specify:

• The ownership proportions of each party.
• Entitlement to rental income.
• Entitlement to sale proceeds.
• Repayment of deposits or capital contributions.
• How future gains and losses are to be shared.

As a Declaration of Trust is a legal document affecting property rights, it should generally be prepared by a suitably qualified solicitor.

Using a Declaration of Trust to Change Ownership

In some cases, a Declaration of Trust simply records the ownership interests that already exist.

However, it can also be used to change beneficial ownership.

For example, a married couple may currently own a rental property equally but decide that future rental income should largely be taxed on the spouse with the lower income. They may therefore decide to change the beneficial ownership from 50:50 to 99:1.

Where spouses wish to change their beneficial interests, a Declaration of Trust is commonly used to implement and document the revised ownership arrangement.

However, changing ownership should never be viewed solely from an Income Tax perspective. The wider tax implications must also be considered.

Capital Gains Tax Implications

Where beneficial ownership is transferred between spouses or civil partners who are living together, the transfer will generally take place on a no gain/no loss basis for Capital Gains Tax purposes.

This means that there is usually no immediate CGT liability when the transfer occurs.

However, the receiving spouse effectively acquires the transferring spouse’s base cost and the revised ownership proportions will determine how any future gain is allocated when the property is eventually sold.

Although an immediate CGT charge may not arise, the long-term implications should still be considered, particularly where the property is a buy-to-let investment, holiday home or second property.

Stamp Duty Land Tax Considerations

Whilst Capital Gains Tax is often not an immediate concern when transferring interests between spouses, SDLT can be a significant consideration.

Many property owners assume that no SDLT can arise because no money changes hands. Unfortunately, this is not always the case.

Where a property is subject to a mortgage, the spouse receiving the larger ownership share may effectively assume responsibility for part of the other spouse’s share of the debt. HMRC can treat this assumption of debt as chargeable consideration for SDLT purposes.

For example, suppose a husband and wife jointly own a rental property with an outstanding mortgage of £90,000. If one spouse transfers most of their beneficial interest to the other, the receiving spouse may be regarded as taking on responsibility for a substantial proportion of the existing mortgage.

Depending on the circumstances and the amount of debt assumed, an SDLT liability may arise.

In addition, mortgage lender consent may be required before any transfer of beneficial ownership takes place.

Form 17 Elections

Even where a property is beneficially owned in unequal shares, HMRC will generally continue to apply the 50:50 rule to spouses living together unless a valid election is made.

This is achieved through HMRC’s Form 17, known as the “Declaration of beneficial interests in joint property and income”.

Once a valid Form 17 election is submitted, rental income will be taxed according to the spouses’ actual beneficial ownership interests.

For example, if a Declaration of Trust confirms that a property is owned 99:1, a successful Form 17 election will result in the rental income being taxed on the same 99:1 basis.

Form 17 Cannot Create a Different Income Split

A common misunderstanding is that Form 17 allows spouses to choose any income split they wish. This is not correct.

Form 17 does not create beneficial ownership. It merely informs HMRC of the ownership interests that already exist.

The income split must therefore mirror the actual beneficial ownership of the property.

If spouses wish to change the allocation of rental income, they must first change the underlying beneficial ownership, which can be done via declaration of trust.

Conditions for a Valid Form 17 Election

For a Form 17 election to be valid:

• Both spouses must sign the declaration.
• The declaration must relate to a specific property or asset.
• Evidence of the beneficial ownership proportions must be available.
• The form must be submitted to HMRC within 60 days of the date of the last signature.
• The declaration cannot be backdated.

If the form is submitted late, the election will be invalid and the default 50:50 treatment will continue to apply until a valid declaration is made.

Property Must Be Held as Tenants in Common

For spouses who wish to be taxed on rental income in unequal proportions, it is important to understand how the property is owned.

Many married couples own property as joint tenants. Under a joint tenancy, there are no distinct ownership shares, as each owner is entitled to the whole property. As a result, it is generally not possible to establish unequal beneficial interests whilst the joint tenancy remains in place.

Where spouses wish to establish unequal beneficial ownership shares, the beneficial joint tenancy must usually be severed so that the property is held as tenants in common. A Declaration of Trust can then be used to document the beneficial ownership proportions.

This is important because a Form 17 election can only be made where the spouses have defined beneficial interests in the property.

Once the beneficial ownership has been established and properly documented, a Form 17 election may be submitted to HMRC so that rental income is taxed in accordance with those ownership interests.

When the 50:50 Rule Does Not Apply

The special 50:50 rule only applies to spouses and civil partners who are living together.

It does not apply to:

• Unmarried couples.
• Parents and children.
• Siblings.
• Business partners.
• Other joint owners.

In these situations, rental income is generally taxed according to the parties’ actual beneficial ownership interests from the outset.

Similarly, where spouses own property together with a third party, the special 50:50 rule will not usually apply.

Is the Planning Worthwhile?

For many couples, changing beneficial ownership and submitting Form 17 can generate significant Income Tax savings.

However, the potential savings should always be weighed against:

• SDLT liabilities that may arise.
• Legal costs associated with changing ownership.
• Mortgage lender requirements.
• Long-term Capital Gains Tax implications.
• Estate planning considerations.

A solution that appears attractive from an Income Tax perspective may not necessarily be beneficial once all of the wider tax implications are taken into account.

Need Advice?

The interaction between beneficial ownership, Declarations of Trust and Form 17 elections is frequently misunderstood. Whilst the tax savings can be significant, changes to ownership structures can have implications for Income Tax, Capital Gains Tax, Stamp Duty Land Tax and inheritance planning.

If you are considering changing ownership proportions, preparing a Declaration of Trust, making a Form 17 election or reviewing the tax efficiency of your property portfolio, we can help.

Please contact us to discuss your circumstances. We will be happy to advise on the tax implications, identify potential planning opportunities and help ensure that any arrangements are structured in the most tax-efficient manner possible.