This alternative method means that parents can subsidise their offspring and still keep their savings intact. There is also an added bonus of a minimal tax bill if correct procedures are followed.
What Has To Be Done?
· The parent(s) purchase a property (outright or via a mortgage) which is legally owned jointly with the student.
· The student resides in the property (rent free!) whilst undertaking their studies.
· The property is also let to other students who pay rent to the student as owner.
· The student uses the rent to finance his/her own personal expenditure
How Does This Work In Practice?
Many assume that when a property is owned on a joint basis any rental income received is also taxed in accordance with the same percentage proportion of ownership. For example, where a property is owned 50:50 then the assumption is that the rent must be taxed using the same 50:50 proportion. However, this is not necessarily the case. The rent could be shared in varying proportions calculated to produce the maximum tax advantage for each owner, especially if one owner is a higher rate tax payer and the other a non or basic rate taxpayer.
The purchase deed of 54 Dorchester Place, Oxford, shows that the property is owned jointly by John and his daughter Jane in the proportion 90:10. John is a 50% taxpayer, while Jane is a student and as such is a non-taxpayer. The net rental income for the year is £7,000.
Normally this would mean a tax bill of £3,150 for John on a 90% share of the income taxed at 50% whereas Jane would have no tax liability as the amount allocated to her is 10% i.e. £700 (which is covered by Jane’s personal allowance).
On these figures, Jane will have to find another source of income to pay for her university living expenses unless Jack can subsidise her out of his already taxed income. The use of this proportion is therefore neither tax nor cash efficient.
It would therefore be more beneficial for the 90:10 split to be in Jane’s favour. This would give Jane an income of £6,300 - just short of the personal tax limit of £6,475. The balance of £700 would be allocated to John to be taxed at 50% producing a tax bill of just £350.
John would still have £350 (i.e. £700 - £350), which is just enough to pay for any minor property repairs. The result of using this allocation is a tax saving of £2,800 per year and most importantly cash income – tax free - for Jane of £6,300 per year (a massive £18,900 over the three years that she is at university).
What Does HMRC Think Of This Arrangement?
HMRC do not appear to mind at all! To quote from section 1030 of their ‘Property Income Manual’ under the heading ‘Jointly owned property – no partnership’:
“joint owners can agree a different division of profits and losses and so occasionally the share of profits or losses will be different from the share in the property. The share for tax purposes must be the same as actually agreed.”
It would, however, be advisable to draw up a formal agreement in case HMRC require confirmation of the allocation. If written correctly, this agreement could accommodate any change in the owners’ individual circumstances and the personal allowance amount on an annual basis.
The agreement should preferably be reviewed before the beginning of each tax year to record the allocation to apply for the coming year. An additional point (should HMRC query the allocation) is to ensure that the rental monies are paid in the correct proportions into each individual’s bank account, reflecting the agreed share of income.
Importantly, the agreement will have no effect on the allocation of Capital Gains should the property be sold at a later date. Any taxable chargeable gain arising would be divided based on the actual ownership share as per the purchase deed; in the example given above, 90% would be charged to John and 10% to Jane.
Property Owners Who Are Married Couples
Married couples or civil partners who own property in joint names are automatically taxed using a 50:50 allocation. Therefore this tax planning exercise only works if the property owners are unmarried. However, if the property is owned on a ‘joint tenancy’ basis, married couples can still take advantage of this tax saving scheme by the use of a Declaration of Trust. Property owned on a ‘tenants in common’ basis will already have an agreed allocation in place.
Explanation of Terms
Joint Tenancy: Spouses and civil partners usually own property as ‘joint tenants’ which gives equal rights over the property such that should one of the owners die, the other automatically becomes the sole owner. This would be the case even if a Will had been drawn up which left the deceased owner's ‘share' to someone other than the co-owner.
Therefore to enable the same tax planning exercise to be followed a Declaration of Trust and HMRC form 17 need to be signed. The Declaration is a legal document confirming the proportion in which the property is owned as distinct from the usual 50:50 share. That proportion will be used for both the capital share and the rental income.
The vital point here is that form 17 must be submitted to HMRC within 60 days of the Declaration otherwise the Declaration will have no effect. The revised allocation takes effect from the date that the Declaration is made.
Even though the division of ownership proportion has been revised the inheritance rules remain that on death the property automatically passes to the surviving spouse.
Tenancy in Common: This method of owning property compares with the ‘joint tenants’ rules in that each owner is allocated a distinct share of the property. For example, Mr A could own one third of the property with the remaining two thirds being owned by his wife, Mrs A. Under this form of ownership, if one owner dies, that owner’s share passes to whoever is specified in the Will, which need not necessarily be the spouse. If there is no Will, ownership passes in accordance with the rules of intestacy.
It is easier to take advantage of the tax saving plan discussed as there are no further forms to sign – owning as ‘tenancy in common’ automatically apportions both the legal and beneficial ownership in the allocation stated on the Purchase Deed. In these circumstances, it is important that a Will be drawn up which names the chosen beneficiary of that particular share of the property as the share will not automatically pass to the spouse on death.
The tax saving plan detailed above is clearly beneficial from an income tax point of view, however, care must be taken when the property is sold. Regardless of how the rental income is treated for income tax purposes it is the underlying beneficial ownership that determines the Capital Gains Tax treatment.
Therefore the allocation must ensure that the full Capital Gains Tax allowance can be used by each owner. This may not be the case for a married couple who had chosen a 90:10 split, therefore the Declaration would need to be revised preferably a few months prior to the actual sale of the property enabling time for the required changes to be recorded by HMRC.
The plan is only available for adults over the age of 18 as the personal allowance cannot be used against income that comes directly or indirectly from a parent.
If other students shared the property with the owner, a claim for ‘Rent a Room’ relief could be made for income tax and, so long as the property remained Jane’s ‘Principal Private Residence’, on disposal the property would be exempt from CGT. This would allow the personal allowance to be used against any other income.
Declarations of Trust should be limited to confirmation of the beneficial interest of each owner; any indication as to who should receive the share on death should be stated in a Will drawn up by a solicitor.
By Jennifer Adams