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Watch Out for the Changing Tax Rates ‘Spring Trap’ for Property Investors!

Watch Out for the Changing Tax Rates ‘Spring Trap’ for Property Investors!
Changes in capital gains tax (CGT) rates announced by Chancellor George Osborne in the emergency budget have taken property investors back to the days of the three Kings...


While CGT rates were at the 18% flat rate, if a married couple sold jointly owned investment property, it didn’t really matter if one was a higher rate (40%) taxpayer because CGT did not take this in to account.


Now, with CGT charged at 18% for lower rate taxpayers and 28% for higher rate taxpayers, tax due on a 50% property share can vary widely. That’s where our three Kings come in - Mr King, a tax inspector, and coincidentally Mr Kings and his wife.


Kings v King


Kings v King is a well-known case that went in front of the tax commissioners in 2004. Mr and Mrs Kings jointly owned their home but decided to move out and live elsewhere and let the property to tenants.


Mr Kings (the husband) set up the tenancy agreement in his own name and all the rent received went in to his personal bank account.


Mr King (the taxman) argued that Mrs Kings had signed over her rights to the rent and Mr Kings (the husband) should be taxed on the whole profits.


Now this is fine while Mr and Mrs Kings are both taxed at the same rate. But because Mr Kings was a higher rate taxpayer, the result was the couple paid a whole lot more in income tax on their rental profits.


Solution


Mr Kings (the husband) should have considered setting up the tenancy agreement in joint names with his wife and paying her share of the rent in to a personal bank account in his wife’s name.


By doing this, it is clear that Mrs King was entitled to a share of the rent and her husband lost control of the cash by paying the proceeds in to an account that he could not access.


If they had sold the property under current CGT rules, Mr Kings would pay CGT on all the gain at 28% when the couple potentially could have saved thousands by rescheduling their share in ownership to take advantage of Mrs Kings paying tax at a lower rate.


Example


Let us introduce a fictional Mr and Mrs Queen to demonstrate this. Mr and Mrs Q own a letting property that they are selling for a net gain of £30,000 after reliefs and allowances.


If they own the property 50:50, Mr Q, a higher rate taxpayer, pays tax on £15,000 at 28%, which is £4,200, while Mrs Q, who has no other income, pays tax on her £15,000 at 18%, which is £2,700.


If the couple did some arithmetic before the sale, Mr Q could be left with a share in the property that is cancelled out by his £10,100 annual exempt amount for capital gains tax, while Mrs Q paid tax on the rest at 18%, saving them about £1,500 in tax.


Be careful with switching the percentages because there’s no point in giving Mrs Q an extra share that makes her a higher rate taxpayer if Mr Q already pays tax at the same rate.


Don’t forget, you can’t change the share of equity each spouse (or civil partner) holds on a whim. The procedure generally involves a declaration of trust and filing specific forms with your tax office within a time limit. 


Practical Tip


If you are a married couple or a civil partner jointly owning investment property and one of you is a lower rate taxpayer, check to ensure that you are not inadvertently signing away your rights to your partner who pays tax at the higher rate.


By Steve Sims