Who pays property tax on a buy-to-let home?
Working out who pays tax on buy to let property can be confusing. This post provides buy-to-let advice for potentially confused investors.
Working out who pays property tax is confusing for some investors who sometimes have complicated arrangements over who owns a buy-to-let home.
HM Revenue & Customs (HMRC) will look for the ‘beneficial owner’ – and those people aren't necessarily the individuals who owners believe them to be.
The rule of thumb for identifying a beneficial owner is looking for the person who benefits from receiving the rent or proceeds from the sale of a rental property.
These are the people who have to submit a self-assessment tax return and who must complete a capital gains tax return when a property is sold.
The names on the mortgage or title at the Land Registry aren't necessarily the beneficial owners.
Beneficial ownership scenarios
For instance, a friend or relative may have offered to help with the deposit to buy on condition that when the property is sold, the money they handed over plus interest is paid back.
As they are benefitting from the disposal, they're a beneficial owner and should declare their income from rents and gain pro rata their share of ownership. If they handed over 25% of the purchase price, they should declare the same share of the gain on disposal.
Another common scenario is when parents buy a home for their student son or daughter at university and let them keep the rent for managing the property and dealing with other student tenants.
The parents, not their child, should declare the rent as income and pay tax on any profits.
A third scenario is an uncommercial let – a property where a friend or relative is allowed to live for free or at a rent that just covers the mortgage.
No rent is declared as HMRC considers the amount received tax neutral. However, on the sale of the property, the owners have to declare any capital gain.
Agents don’t pay tax
The point to watch is the person collecting the rent is not just acting as an agent. If they are, the rent and disposal proceeds still belong to the beneficial owners. The arrangement is no different from having a professional letting agent as the letting agent pays no tax on the rental profit or disposal, the beneficial owners do.
So, where mum and dad perhaps let friends or relatives keep the rents for managing a buy-to-let portfolio on their behalf, they cannot choose to allocate the tax to a third party. The law says as beneficial owners they must account for income tax on rents or capital gains tax on the disposal proceeds.
Of course, if someone has lent money to someone to buy a property, this doesn't make them a beneficial owner in the same way as a buy-to-let mortgage lender has no responsibility for tax on rental profits or property gains.
Deciding who is beneficial owner
HMRC follows a procedure for identifying beneficial owners.
How this happens was set out in the case of Lawson v HMRC, which went before the First Tier Tribunal in 2011.
The five indicators are:
- Who holds legal title to the property?
- Who occupies the property?
- Who is entitled to the rental income from the property?
- Who provided the money to buy the property?
- Who received the proceeds from the sale of the property?
In this case, Yvonne Lawson was listed as the legal owner of a house in Northampton where her daughter lived while attending college.
When the property was sold, Mrs Lawson shared the capital gain with her husband.
HMRC argued that as Mrs Lawson was listed as the sole legal owner and all the proceeds from the sale were paid into her personal bank account, her husband wasn't a beneficial owner and she should have paid all the tax due.
The issue was by including her husband as an owner; Mrs Lawson claimed the annual exempt allowance for capital gains tax twice, which reduced the chargeable gain.
She lost the case and was reassessed for capital gains tax on the higher amount without including her husband’s annual exempt amount.
To make sure the right person is paying property taxes, it’s a good idea for buy-to-let landlords to set out a minute in their financial records to answer these questions.
Keep an eye on any changes from life events, such as marriage or divorce, as these could change the beneficial ownership.
Beneficial ownership tax trap
Failing to do so could see a tax demand arriving some years after the property was purchased.
This might lead to penalties for making careless or deliberate errors on a tax return and a stack of fines and interest.
Some landlords who pay higher rate tax (40%) slip into the trap of switching rents and sale proceeds to a basic rate taxpayer (20%). This is not a problem if the transfer of ownership is correctly switched using a Form 17 and a declaration of trust or by a solicitor’s conveyance.
When this transfer is completed, HMRC will expect to see rental profits and capital gains split according to each taxpayer’s share of ownership.
However, spouses who are joint owners who haven't legally completed the transfer will be assumed to own a buy to let 50:50 and have the tax responsibility shared accordingly.
Had Mrs Lawson followed the Form 17 or conveyance rules, she would have won her case as HMRC couldn't have disputed her husband was a beneficial owner of the sold property.