. Allocating income for tax when property is jointly owned
· Splitting capital and revenue expenditure
· What counts as a garden for private residence relief?
Allocating income for tax when property is jointly owned
Property that is jointly-owned may be let out. As people are taxed individually, the income must be allocated in order to work out the tax that each joint owner is liable to pay. The ways in which income from jointly-owned property is taxed depends on the relationship between the owners.
Joint owners are not married or in a civil partnership
Assuming there is no property partnership, where property is jointly-owned by persons who are not married or in a civil partnership, the income arising from the property will normally be allocated in accordance with each person’s share in the property. Each person is taxed on the income that they receive.
Andrew, Alison and Anthony are siblings who own a property together which is let out. Andrew owns 50% of the property, Alison owns 30% and Anthony owns the remaining 20%.
The property generates rental income of £10,000. The income is allocated as follows in accordance with the ownership shares:
· Andrew: £5,000;
· Alison: £3,000; and
· Anthony: £2,000.
Each is taxed on the share that they receive.
The joint owners do not have to share profits in accordance with their ownership shares – they can agree a different split. If they do, they are taxed on what they actually receive.
Spouses and civil partners
Where property is owned jointly by spouses and civil partners, the default position is that the income is treated as being allocated 50:50 for tax purposes, regardless of the amounts that they actually receive. This can be useful from a tax planning perspective where spouses or civil partners have different marginal rates of tax. The no gain/no loss capital gains tax rules can be used to transfer a small share in a property to a spouse or civil partner paying tax at a lower rate, transferring 50% of the income for tax purposes in the process.
Frank is a higher rate taxpayer. He owns a property generating rental income of £20,000 a year. He transfers a 5% stake in the property to his wife Felicity, whose only income is a salary of £15,000. Frank and Felicity are each taxed on £10,000 of the rental income.
Felicity pays tax at 20% on her share. Had the property remained in Frank’s sole name, he would have paid tax at 40% on the full amount of the rental income. Taking advantage of the rules saves them tax of £2,000 a year.
This rule does not apply to income from furnished holiday lettings.
Where spouses or civil partners own a property jointly in unequal shares, they can elect for the income to be taxed by reference to their underlying ownership shares. However, this is only possible where they own the property as tenants in common (and each own their own share); where the property is owned as joint tenants (and as such the owners have equal rights over the whole property), the income split remains 50:50.
The election is made on Form 17. It must be made by both spouses/civil partners jointly and they must declare that they own the property in the shares stated on the form. The income split takes effect from the date of the latest signature, and to be effective must reach HMRC within 60 days of the signature.
The ability to elect for income to be taxed in accordance with ownership shares opens up tax planning opportunities, particularly as use can be made of the capital gains tax no gain/no loss rules for transfers between spouses and civil partners to change the ownership slip without triggering a chargeable gain.
Splitting capital and revenue expenditure
When it comes to tax relief for expenditure, not all expenditure is equal. The relief, if any, that is available, depends on whether the expenditure is capital or revenue, and for capital expenditure on whether the accounts are prepared on the cash basis or the accruals basis.
When doing up a property, it is important to understand whether the expenditure is capital or revenue, and where necessary apportion costs to the correct camp.
Capital and revenue expenditure may be incurred at the same time. Where this is the case, the expenditure will need to be split between the capital component and the revenue component so that each part can be treated correctly for tax purposes. The need to split expenditure is most likely to arise where a property is being renovated or extended. Where this is the case, the project may include elements of repair and maintenance as well as capital improvement.
When undertaking repair and improvement work, the line between capital expenditure and revenue expenditure can become blurred. In renovating a property, repairs may be carried out at the same time. Expenditure on repairs remains allowable, subject to the condition that it is incurred wholly and exclusively for the purposes of the business. To identify the deduction for repairs, the costs must be split. However, where alterations are carried out that are so significant as to amount to the reconstruction of the property, the full amount of the associated expenditure will be capital expenditure. Expenditure will only be allowable as repair expenditure in relation to any parts of the old building that are preserved.
Making the apportionment
If the contractor provides one bill covering both capital and revenue expenditure, the costs will need to be apportioned. To do this, it is necessary to identify what work counts as repair work and what work counts as improvement work. HMRC allows expenditure to be ‘apportioned on a reasonable basis to estimate the amount attributable to the repair element’. Where the bill is itemised, splitting the total between capital and revenue should be fairly straightforward. However, HMRC stress that any split ‘must be done fairly and the figures will be open to review’. To back up the split, it is helpful to keep any relevant documentation, such as evidence of initial discussions and initial estimates, plans and suchlike. For example, emails discussing how part of the building may be repaired may be useful to support the contention that the associated expenditure is deductible revenue expenditure rather than capital improvement expenditure.
What counts as a garden for private residence relief?
Private residence relief prevents a tax charge from arising if there is a capital gain when a person sells a property that has been their only or main home throughout the period that they have owned it. Where the property has been the only or main home for some but not all of the period of ownership, the relief shelters the gain pertaining to the period that the property was occupied as the only or main home, and also the final nine months of ownership (36 months when owner moves into care).
In most cases, the garden will fall within the scope of the relief, and separate consideration is not needed. However, where the grounds are particularly extensive problems may arise and it is certainly not a given that they will be covered by the relief.
Under the terms of the legislation, land or a garden that has been ‘enjoyed with the property’ will fall with the scope of the relief where the size of the garden does not exceed the ‘permitted area’.
The legislation defines the ‘permitted area’ as an area of 0.5 of a hectare (1.23 acres) including the land occupied by the dwelling house. Thus where the garden and grounds are not more than 0.5 of a hectare, as long as the conditions for the relief are met, the whole area automatically qualifies for relief.
However, the land must comprise the gardens and grounds of the residence – land which does not form the garden and grounds does not qualify for the relief, even of the total amount of land disposed of with the residence is not more than half a hectare. The test is house and garden up to 0.5 hectares, not the first 0.5 hectares of land.
If the grounds are more than 0.5 hectares, all is not necessarily lost. A larger area may be allowed within the scope of the relief where this is considered necessary ‘for the reasonable enjoyment of the property’. In determining whether this test is met, HMRC will take account of:
· the size and character of the dwelling house;
· the part of the dwelling house that has been used as the owner’s residence; and
· the amount of land that is required for the reasonable enjoyment of the residence.
Urban gardens are smaller than those of homes in rural areas and what might be reasonable for a rural property may be regarded large for a property of the same size in an urban setting.
Problems can also arise if some of the garden is sold separately from the house.
Care should be taken when selling some of the land separately and retaining the dwelling as HMRC may argue that the land that was sold was not required for the reasonable enjoyment of the property. This argument could be countered where the sale was for financial reasons or where the disposal was within the family.
Land sold after the disposal of the residence will not qualify for main residence relief as at the date of disposal the land is not held with the residence as its garden or grounds – the test applies at the date of disposal rather than over the period of ownership as a whole.