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Getting married or becoming civil partners comes with many tax benefits. However, for landlords, it could result in significantly higher income tax bills if they need to be made aware of a key tax rule change. This article explains why there’s a tax trap and the steps landlords can take to prevent paying extra tax.
A general principle of UK tax law is that income from jointly owned assets is taxed based on the ownership share. For example, two friends who co-own a rental property as tenants in common with a 50/50 split would each pay income tax on 50% of the profits, even if one friend collected all the rent.
However, there’s more flexibility when the co-owners are unmarried. In that case, they can create a profit-sharing agreement to allocate rental income unequally for tax purposes.
Take the example of Dev and Asmaa. They live together and co-own a rental property as 50/50 tenants in common. However, Dev pays a basic tax rate while Asmaa pays a higher one. They have a written agreement to reduce their tax bill, which states that Dev is entitled to 95% of the profits and Asmaa just 5%. This tax planning technique can generate major savings.
With £12,000 in annual rental profit after expenses, the agreement cuts their collective tax bill by £1,080 compared to splitting everything 50/50. While HMRC dislikes tax-motivated agreements, it usually accepts them as long as they are properly documented.
Here’s the tax trap. If Dev and Asmaa get married, the profit allocation agreement becomes invalid. Income from joint assets is automatically split 50/50 between spouses and civil partners, regardless of contract.
In our example, even with the 95/5 agreement, HMRC would still tax Dev and Asmaa on £6,000 of rental profit each after marriage. Their tax planning structure collapses.
This catches many newlyweds off guard. They continue allocating profits unequally on their tax returns, unintentionally misreporting income. Asmaa could face an HMRC enquiry for underpayment if she only declares 5% of rental profit after marriage.
To maintain tax efficiency and flexibility, unmarried co-owners have two options upon marriage:
- Transfer ownership shares. In our example, Asmaa could transfer part of her share to Dev, bringing his ownership to 95%. HMRC will tax rental income based on the new proportions if they make a proper joint election.
- Set up a partnership. Creating a formal rental business partnership allows married couples to share profits flexibly for tax purposes without altering ownership. The partnership structure overrides the 50/50 deemed profit allocation.
Co-ownership and tax planning can become messy after marriage. But with planning, it’s possible to retain control over how rental income is taxed. Don’t risk overpaying your taxes! Call our expert tax accountants today to ensure you’re not paying a penny more than you owe.