How married couples can reduce tax burden of buy-to-let

The tax changes brought in with effect from April 5 2016 should be on investors’ radar as they relate to the taxation of rental income from buy-to-let properties. They affect the tax relief you get in respect of finance costs and replacement of soft furnishings. Needless to say these changes will result in most taxpayers paying more in income tax.

We are already well into the first year of these changes and for the current tax year, relief on 25 per cent of your finance costs will be restricted to the basic rate of tax. Over the next three years this relief will be further restricted until the tax relief on all of your finance costs will be limited to the basic rate of tax only. For this purpose, finance costs will not just relate to the mortgage interest you pay but will also include any additional costs of borrowing, such as the fees the bank charge you for setting up the loan.

In addition to the restriction on finance costs, the former allowance to cover the price of replacing soft furnishings when you let a property fully furnished has also changed. You will no longer be able to claim a standard allowance of 10 per cent of the rental income. Instead you will now be restricted to the actual costs of replacement.

Our clients have been asking us if there is any way the results of these unexpected and unwelcome tax increases can be reduced or avoided. If you are married or in a civil partnership and either of you own a property in your own name then the short answer is that there may be an alternative available to you if the circumstances are right.

This is due to the special rules that apply to income received by married couples from jointly-owned property. The basic rule is that income from jointly-owned property is split equally between spouses regardless as to how the property is actually owned. These special rules allow married couples to vary the share of income on which they pay tax between themselves. This is referred to as a form 17 election after the number of the form on which married couples formally notify H M Revenue & Customs (HMRC) on how properties are owned between them and how income should be apportioned between spouses.

There are two ways in which these rules can be applied to reduce the overall tax bill.

The first is by making a form 17 election under circumstances where the legal ownership is not 50/50. So, for example, if you are a higher rate taxpayer and your spouse is a basic rate tax payer or doesn’t pay tax at all then consider gifting 75 per cent of the property to them and making an election so that the rental income is split 25/75 instead of the more usual 50/50. Don’t forget that gifts between spouses are exempt from tax so any gifts can be done without incurring any tax liabilities. You may have to give HMRC some evidence of the actual split of the ownership by using a declaration or deed.

The second way is by gifting your spouse a small percentage, say five per cent, of the property and then not making an election on form 17. As mentioned above, the basic rules are that HMRC will automatically apportion income on a 50/50 basis unless an election is made so regardless as to the actual ownership HMRC will simply split the income 50/50.

If you want to make an election you need to do this before April 5 in order for the election to apply for the tax year starting on April 6 2017. Unfortunately, you cannot backdate the election.

Also bear in mind that that the election can cover any joint income sources and not just rental income so can apply to other assets as well as property.

Robert Peel is private clients manager at Garbutt and Elliott, which has offices in Leeds and York.