Avoiding the mortgage interest relief restriction by transferring properties to a spouse
Due to the lower tax on profits enjoyed by companies, greater reinvestment of profits is possible in order to reduce mortgages and grow the business, and although further tax arises when funds are extracted from the business (usually as dividends), the overall tax paid on those profits should not exceed the tax currently paid by an individual or partner, even with the recently increased tax rates on dividends.
By incorporating your property business you would be able to:
Continue to offset 100% of the mortgage interest costs against your property income
Pay 17% corporation tax instead of the current 20% by 2020
However, before considering incorporation, its worth considering whether you could be better off splitting your property profits in favour of a lower earning spouse or civil partner. This may be the case if you can answer "Yes" to the following questions:
Are you married/in a civil partnership?
Do you own property investments between you?
Is one person a higher rate and the other a basic rate taxpayer?
If the answer to the above questions was yes, you could be better off splitting your property profits in favour of the lower rate taxpayer, particularly as it’s a useful way of countering the effect of the cuts to mortgage interest relief, as it avoids you being taxed on profits at the higher rate.
A quick caveat here as although you can transfer properties to a spouse or civil partner free of CGT, for SDLT purposes any consideration given for the transfer would be taken into account. In most cases there wouldn't be any consideration on an interspouse transfer, however if there is an assumption of liability for any debt by the transferee spouse this would be taken into account. Therefore care needs to be taken with a transfer of a property subject to a mortgage.
If you were interested in transferring an interest to a lower earning spouse or civil partners it should also be borne in mind that irrespective of legal ownership, HMRC will assume spouses own a 50/50 share in all property unless you tell them otherwise?
What is a deed of trust?
A deed of trust is a legal document that dictates the capital and revenue interests in a property. 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%.
What are the benefits of a deed of trust?
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 on the lower taxpayer’s income.
A deed of trust is, in effect, 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 that a lower taxpaying spouse can be classed as the one benefiting from the rental income. There is also a separate form a form 17 that informs HMRC of the split in the beneficial interest.
The deed of trust and form 17 should 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
If the couple divorce then the assets will remain 50/50 until the divorce settlement has been finalised.
Step by step guide to implement this strategy
1 – Identify whether you’d pay less tax by changing the ownership between a higher and lower rate taxpayer
2 – If so, speak with your solicitor and get them to do a deed of trust specifying how you want the income to be split
3 – Complete a Form 17 to inform HMRC of the deed of trust
4 – Send the form 17 with a copy of the deed of trust to:
Self Assessment, HM Revenue and Customs. BX9 1AS. United Kingdom