If you and a spouse jointly own a rental property and pay income tax at different rates then warning bells should be ringing as an income shifting tax opportunity is beckoning you.
Income shifting is a common strategy to minimise income tax on earning generated by investments and capital gains tax on any profits made when they are sold.
The principle is straightforward – shuffle asset ownership so the owner paying tax at the lowest rate owns the largest share.
Income shifting is perfectly legal and easy to set up but has to follow a strict evidence and filing procedure with HM Revenue & Customs (HMRC).
Who qualifies for income shifting?
Any joint owners of rental property, shares, savings accounts and other income generating assets, but income shifting works best for married couples and civil partners.
This allows married couples to shift their finances between each other without triggering capital gains tax, but unmarried joint owners have no such advantage.
One solution for unmarried joint owners is to set up a tenancy in common when buying a rental home.
How to alter property ownership
The joint owners instruct a lawyer to draft a declaration of trust detailing the new percentage shareholdings of the property each will own.
The owners sign and date the declaration.
The declaration adjusts the shareholding for tax purposes from the date on the document, proving the owners serve the declaration on HMRC with a Form 17 within 60 days of that date.
- If a Form 17 is signed on April 5 and filed no later than June 4, the shareholdings apply for the whole tax year
- Property owners can file as many Form 17s as they wish during a tax year as long as they are supported by a new declaration of trust
- If the property has a mortgage and share ownerships change, stamp duty may be due on any transfer valued at more than £125,000. This depends on whether the change in ownership also means the receiving owner is also taking over more of the mortgage.
How income shifting works
Peter is married to Samantha and they own a letting property that returns a £15,000 rental profit each tax year. Peter is a higher rate tax payer (40%), while Samantha is a mum with a part-time job earning £15,000 a year. Samantha pays tax at 20%.
They have made no income shifting election, so HMRC assumes they split their rental profits 50:50.
- Peter’s tax on his profit share is 40% of £7,500 or £3,000
- Samantha’s tax on her profit share is 20% of £7,500 or £1,500
- Total income tax due on rental profits is £4,500.
Peter and Samantha can make a declaration of trust that lets them change their shareholding in the property to give Samantha more of the rental profit splitting ownership 95:5 in favour of Samantha.
A Form 17 and declaration of trust are filed with HMRC to evidence the transfer of ownership.
Peter’s profit share drops in the next tax year to £750, while Samantha’s increases to £16,750.
This alters the tax the pay:
- Peter’s tax on his profit share is 40% of £750 or £300
- Samantha’s tax on her profit share is 20% of £16,750 or £3,350
- The total income tax due on the rental profit is £3,650, saving the couple £850 a year
Any capital gains tax computation on the sale of the property would also reflect the 95:5 shareholdings, but both would receive the annual exempt allowance (£11,100 in 2015-2016) to offset against any gain in value.
Read more information about the Form 17 procedure and income shifting for married couples on the HMRC web site