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There are presently a variety of income tax rates in operation in the UK, all of which are potentially applicable to the taxation of property income. These start from nil, where income is covered by personal allowances, continue through both 20% basic rate and 40% higher rate bands, before reaching 50% (45% from 6 April 2013) where taxable income exceeds £150,000. In addition, where income exceeds £100,000, personal allowances are gradually tapered away until none remain upon reaching an income level of £116,210.
As a result, there are significant tax planning opportunities, in relation to property owned jointly by husband and wife (or by civil partners), and there may be potential to assign the income derived from such an asset on a more favourable basis. In addition, where one spouse owns property and receives the income from it, there is additional potential for tax planning regarding the allocation of the ownership of the property itself, which will have a positive effect on the ownership of the income for tax purposes.
Assigning income between spouses
In addition to their main or principal private residence, many married couples will own investment property which generates significant income. The rental market is currently very positive and strong rental income streams can be exploited. If one spouse receives far greater income than the other, it could mean that there are tax planning opportunities to ’assign‘ the rental income from the joint property to the lower earner, and thus reduce the tax bill.
Examples of effective assignment can span a number of tax situations:
Using the personal allowance for one spouse:
Where one spouse is a basic rate taxpayer and the other is not utilising their personal allowance, it would make sense to assign the rental income to the individual with lower (or no) income, so as to use the available tax breaks efficiently.
For example, Mr and Mrs Smith receive £6,000 per annum after expenses from Orchard Cottage, which is owned jointly and let out. If Mr Smith is paying tax at 20% on this income, i.e. £600, it would make sense for him to assign all the income to Mrs Smith, who has no other sources of income. This would result in the income being covered in full by her personal allowance and a tax saving would be achieved. In the event that Mr Smith was a higher rate taxpayer, say at 40%, then the tax saving increases to £1,200.
Benefiting from different tax bands:
If one spouse is in a different rate band, this too can be utilised to generate a tax saving.
For example, Mr and Mrs Brown receive £12,000 per annum after expenses for Rectory Cottage, with Mrs Brown earning £105,000 per year and Mr Brown earning only £15,000 per year. If the rental income is split 50/50 between them, then the rental income will push Mrs Brown into a position where she loses a large proportion of her personal allowance, giving a very high effective rate of tax. It would make sense therefore to assign the income from the joint property to Mr Brown, who will only be liable for tax at the 20% basic rate.
Loss of personal allowances when income is above £100,000:
With the 31 January tax payment deadline rapidly approaching, there are many taxpayers who are feeling the full impact of having taxable income above £100,000 and facing the very ’tax negative‘ impact of losing their personal allowance.
For example, Mrs Edwards has a salary of £110,000 which is taxed through PAYE after deduction of her already reduced personal allowance. Additional rental and investment income then pushes her total income beyond £116,210, reducing her personal allowance to nil and subjecting her to even higher income tax rates in real terms. Clearly, in this scenario it would make sense for Mrs Edwards to assign the rental income to her spouse, assuming that he is in a lower tax rate band.
Capital Gains Tax:
The tax savings to be gained from the allocation of property ownership between spouses is not restricted purely to income tax; there are also potential capital gains tax (CGT) advantages. Where a property is owned jointly by a husband and wife, they will each receive an annual exemption for CGT which can be utilised to gain a tax advantage. There are currently three potential rates of capital gains tax relevant to disposals. These are as follows:-
- 18%, where there is a disposal by a basic rate taxpayer and the gain is within their basic rate band;
- 28%, where the taxpayer suffers tax at higher rates; and
- a 10% rate of tax where a claim for entrepreneurs’ relief is possible.
There are clear tax advantages to be gained by ensuring that property ownership is correctly allocated between spouses, to make sure that annual exemptions for CGT are fully exploited.
Consideration should be given to ensuring that maximum use is made of the 18% rate of CGT, and that at all times entrepreneurs’ relief is used to mitigate the CGT liability, where appropriate.
Practical tip for husband and wife
All ownership of property between husbands and wives should be considered in relation to maximising the basic tax allowances. It is fair to say that most taxpayers are aware of the annual exemption for CGT, and the need to ensure joint ownership of property where appropriate. However, the introduction of the 50% income tax rate and the loss of personal allowances above £100,000 have shown taxpayers the importance of allocating income between spouses in the most tax-efficient way. Many taxpayers are unaware of the ability to assign income between spouses in order to maximise tax savings. The matter is complex and there are large numbers of families who have built up large portfolios of properties, where the beneficial tax treatment of these does not just rest with inter-spouse transfers, but the consideration of passing property down to the next generation.
In general terms, passing the property to the next generation is a basic way of ’assigning income‘ to taxpayers often paying income tax at a lower rate. However, such moves result in potential CGT problems. The key is about ’tax planning in the round‘, to look at all advantages whilst being aware of the pitfalls.
Practical Tip :
As a practical tip, a total review of family property is essential to make sure that current and future income tax and CGT advantages are maximised. Whilst the matter of tax planning is complex, the solution can be reasonably simple. There is still time before 5 April 2013 to ensure that tax efficiency is achieved and this is a very ’advantageous‘ planning window, particularly as the 2012/13 tax year contains a variety of income tax rates. Now is the time for property owners to consider matters very carefully with regard to all property held by family members for short, medium and long-term tax saving goals. Examine all areas of income tax, CGT and inheritance tax as part of a comprehensive review of your circumstances.
This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.