Sarah Bradford looks at when it can be beneficial to transfer an interest in an investment property to a spouse or civil partner prior to sale.
The tax system affords some tax breaks to married couples and civil partners and it is possible, depending on personal circumstances, to use these to mitigate the tax bill arising on the sale of an investment property. The following case study explores some of the tax saving opportunities that may arise.
Case study: Sale of investment property
Martin jointly owns a family home in Leeds with his wife Catherine. He also owns a second property which has been rented out. The investment property is in his sole name. He wishes to sell the rental property to release the funds. The couple are thinking about possibly buying a holiday home on the coast.
Martin is an additional rate taxpayer. Catherine does not work and has no income.
The investment property was purchased for £200,000. It is on the market for £350,000 and looks likely to realise its sale price. There is a mortgage of £100,000 on the property, which will be cleared by the sale proceeds. The cost of sale is £5,000.
It is assumed that the sale will complete in the 2018/19 tax year and that neither Martin nor Catherine will realise any other gains in that year.
Scenario 1 – Property remains in Martin’s sole name
As an additional rate taxpayer, Martin will pay capital gains tax (CGT) on residential property gains at 28%.
The CGT annual exempt amount for 2018/19 is £11,700, and this is available in full to offset against part of the gain.
CGT payable by Martin is as follows:
- Sale proceeds £350,000
- Purchase price -£200,000
- Cost of sale –£5,000 (205,000 total)
- Gain 145,000
- Annual exempt amount ( 11,700)
- Chargeable gain 133,300
- CGT @ 28% 37,324
In this scenario, Martin would face a CGT bill of £37,324.
Scenario 2: Transfer 50% ownership to Catherine
Married couples and civil partners can transfer assets between them at such a value that gives rise to neither a gain nor a loss. This can be useful as it may be beneficial to put assets in joint names before the sale to take advantage.
Catherine has not used her CGT annual exempt amount. She also has her basic rate band available.
Consequently, by transferring some of the gain from Martin to Catherine, it is possible to reduce the overall CGT liability.
The simplest solution is to put the property in joint names, so they own it equally, and to transfer a 50% share to Catherine.
Capital gains tax
The property cost £200,000, and thus a 50% share `cost’ Martin £100,000. If Martin transfers a 50% share in the property to Catherine for £100,000, he will make neither a gain nor a loss. Catherine’s base cost of her 50% share for any future disposal is £100,000.
The CGT payable by the couple on the future sale is as follows:
- Sale proceeds (50:50) 175,000 by Catherine 175,000 by Martin = 350,000
- Purchase price (50:50) (100,000 Catherine) (100,000 Martin) (200,000 total)
- Cost of sale ( 2,500) ( 2,500) ( 5,000)
- Gain 72,500 72,500 = 145,000
- Exempt amount ( 11,700) ( 11,700)
- Chargeable gain 60,800 60,800
- CGT @ 18% (on £34,500) 6,210 (Catherine)
- CGT @ 28% (on £26,300/£60,800) 7,364 17,024 (Martin)
- Total CGT bill 13,574 (Catherine) 17,024 (Martin) 30,598
By putting the property into joint name prior to sale the overall CGT bill is reduced from £37,324 to £30,598 – a saving of £6,726.
Stamp duty land tax
It is not enough to consider CGT in isolation – where a share in a property changes hands, there may also be stamp duty land tax (SDLT) to pay. This will be the case where consideration changes hand. The definition of consideration is not limited to actual money changing hands – it also applies where one party assumes a share of a debt, such as a mortgage.
In this case, there is a mortgage of £100,000 on the property. As Martin and Catherine also have a family home, the SDLT rates that are relevant are those for second and subsequent properties and are payable where the consideration exceeds £40,000.
If Catherine was also to take on a 50% share of the mortgage, the consideration for the sale would be £50,000. Martin’s share of the debt is reduced by £50,000. As this is more than the SDLT second property threshold, this would trigger a SDLT bill of £1,500 (£50,000 @ 3%).
For income tax purposes, where a property is held in joint names by a married couple or civil partners, each spouse/civil partner is treated as being entitled to 50% of the income. Thus, any rent received from letting out the property and prior to the sale would be split between them for tax purposes. As Catherine has no other income, this would be beneficial as she would be able to set her personal allowance against the rent she received.
It is not possible for the couple to elect for all the rental income to be treated as Catherine’s. However, if the actual underlying beneficial interest was not 50:50 (for example, if Catherine owned 75% of the property and Martin owned 25%), they could complete Form 17 (see www.gov.uk/government/publications/income-tax-declaration-of-beneficial-interests-in-joint-property-and-income-17) and elect for the income to be assessed in accordance with their actual beneficial ownership.
Ignoring any income tax consequences, the couple will save £5,226 by putting the property in joint name prior to sale – a CGT saving of £6,726 less SDLT of £1,500.
Scenario 3 – An unequal split
The best-case scenario will not always be for the property to be jointly owned. In the above scenario, tax savings will only arise to the extent that the gain is covered by Catherine’s CGT annual exempt amount or falls within her basic rate band (so that it is taxed at 18% rather than 28%) – on gains of £46,200 (£11,700 + £34,500). Any further gains shifted to Catherine will be taxed at 28% – the same rate as would be payable by Martin on those gains.
To minimise the overall tax bill and to prevent a SDLT liability from arising, the share of the mortgage taken over by Catherine should not exceed £40,000.
Transferring (say) a 32% share to Catherine will achieve the following result.
Capital gains tax
If a 32% stake in the property is transferred to Catherine prior to the sale, the CGT payable by the couple would be as follows:
- Sale proceeds (32:68) 112,000 (Catherine) 238,000 (Martin) 350,000 (total)
- Cost (32:68) (64,000 Catherine) (136,000 Martin) (200,000 total)
- Cost of sale ( 1,600 Catherine) ( 3,400 Martin) ( 5,000 total)
- Gain 46,400 (Catherine) 98,600 (Martin) 145,000 (total)
- Exempt amount ( 11,700)( 11,700)
- Chargeable gain 34,700 (Catherine) 86,900 (Martin)
- CGT @ 18% (on £34,500) 6,210 (Catherine)
- CGT @ 28% (on £200/£86,900) 56 (Catherine) 24,332 (Martin)
- Total CGT bill 6,266 24,332 30,598
As with scenario 2 above, the CGT bill is reduced to £30,598 – it is not necessary to transfer a 50% stake to Catherine to achieve the maximum CGT savings.
Stamp duty land tax
In this scenario, Catherine will take on 32% of the mortgage; equal to £32,000 (32% of £100,000). This is the consideration received by Martin for transferring a 32% stake in the property to Catherine. However, as the consideration is less than £40,000, there is no SDLT payable.
Although in this scenario, the property would be owned in unequal shares, it would make sense for any rent to be split 50:50, as this will result in the lowest overall bill. It is not advantageous to make a Form 17 declaration.
Ignoring any income tax consequences, the couple will save £6,726 by putting the property in joint name prior to sale. In this case, the CGT saving is not reduced by a SDLT bill.
It is necessary to consider any SDLT implications, as well as CGT savings (and also income tax implications where rent will be received prior to sale), in order to arrive at the best result – this will not necessarily be the property being owned equally.