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Will we save tax by purchasing a buy-to-let in our daughter's name?


10-25-2016

The sun illuminates property in the historic city centre on January 16, 2015 in Bath, England

Parents might use buy-to-let to provide an income for their children - but what's the best way to pass a property on? Credit: Matt Cardy/Getty Images
 

We are currently buying with a 40pc deposit and we expect to let for around £8,000 per year.

The idea is to provide an income for my wife, myself and our daughter, who is currently 24, then pass the investment on to our daughter when we die.

We are both 61 and will retire at 66. We have very little pension provision and expect current pensions, including state pension, to amount to about £12,500 a year each.

We also own our own home, which is worth around £400,000. 

I am currently a higher-rate taxpayer, and both my daughter and my wife are non-taxpayers. 

Should we transfer the property to our daughter now, put it in trust, incorporate it or keep it in our own names and leave it to her in our will?

DF, via email

This is a dilemma faced by hundreds of thousands of buy-to-let investors.

Most people will automatically buy new properties in their own name, so it's good that you have thought about this before the purchase has fully gone through. 

You need to take into account inheritance tax and capital gains tax, as well as the tax changes to buy-to-let landlords being introduced next year. Since this is a second home you may also have to take into account extra stamp duty. 

Mortgage

If you have not already secured a mortgage, you will need to take into account your rental income compared to your mortgage costs. 

Ahead of the changes to the tax treatment of buy to let being introduced from next year, many lenders are changing their rental cover requirements. 

Some of them now require you to receive 145pc of your mortgage costs in rental income, an increase from 125pc which was standard last year. 

The Bank of England is also requiring lenders to assess a borrower's wider financial situation. Bear this is mind when applying for a mortgage. 

Based on the property cost and rental income, you should be getting a yield of around 7.3pc, which is high and should mean getting a mortgage will not pose difficulties. 

Stamp duty

If you and your wife buy the property, or part-own it with your daughter, you will have to pay the stamp duty surcharge, which is 3pc of any price above £40,000. 

This is paid by anyone who already owns a property, who is buying another one. For a property of this price that will be around £3,300.

This would also be incurred if you bought the property through a company, or through a discretionary trust. 

There is a way that you could make your daughter the beneficiary of a trust, so that she, a non-homeowner is the official owner.

This would mean no stamp duty would be payable at all, as the property is worth less than £120,000.

However, if you need any income from it, this arrangement will not work.

Rental income

Lucy Brennan, partner at accountancy firm Saffery Champness, explains:  "If the reader wishes to gain income from the property then he must be a beneficial owner, either personally, through a company or through a trust. 

"We can probably exclude a trust in this situation, because of the complexity that a trust brings to the tax position - especially when the ‘settlor’, the person who sets up the trust, who would be the reader, is a beneficiary of the trust."

The changes to rental income being phased in from next year will only affect higher and additional-rate taxpayers - so for this reason it might make sense for your wife or daughter to own the property in their own name.

The Government is removing landlords' ability to deduct their costs from their income before calculating their tax bill. This will be phased in from next year. 

A 20pc tax credit will man basic-rate taxpayers are not affected, except where the extra income pushes them up a tax bracket. 

Therefore the best arrangement depends on how much either of them currently earn, and whether the extra income could push them into a situation where they must pay tax. If they have no income at all this is unlikely. 

You will also become a basic-rate taxpayer in five years. The tax change will not come into force fully until 2020, so this will not affect you as much as it will some others. 

Ms Brennan suggests that for now, part-owning the property with your wife and passing income on to your daughter might be the best method. 

Your wife could own 5pc and you could own 95pc in order to make the most of her non-taxpayer status. 

"He could consider owning the property in joint names with his wife and then gifting up to £3,000 per annum to his daughter under the annual inheritance tax allowance for gifts, or by claiming the rental income passed over is excess income for them. 

"This would give flexibility, and ensure his and his wife’s income needs are met in their retirement," she said.

You and your wife could own the property together, but since she is a non-taxpayer it will make sense for her to take as much of the income as possible. 

Ownership through a company

Mortgage rates when purchasing a buy-to-let through a company tend to be higher, though experts say they are falling. 

Owning it through a company would mean you could keep any funds within the company, and you would only pay income tax at 20pc, a rate which is dropping and will be 17pc by 2020. 

However, in your case the overall costs of owning through a company are likely to make this not worth it. There would be the time-consuming and potentially expensive matter of completing due diligence, such as filing accounts, which you might have to get help with. 

Given that your wife and daughter are non-taxpayers, and that your tax rate will fall in the next five years, the tax on income in the company is similar to the rates that will be paid individually by you and your wife during retirement, and are more than those paid by your wife and daughter now. 

If you were all higher-rate taxpayers, owning through a company would be a more suitable option, especially if multiple mortgaged properties were being bought. 

There may also be a double tax charge if the property is sold.

Tax will have to be paid on capital gains on the property by the company, and either income tax or further capital gains tax may also have to be paid on any money extracted. 

Capital gains tax

If you own the property between three of you, you will be able to use all three of your capital gains tax allowances if it is sold. 

These are currently £11,000 a year each.  Given the value of the property, Ms Brennan estimates that your tax liability will be low once the allowances are used. 

If you sell after retirement, you will pay at the basic rate, which is 18pc. This is paid on the difference between the amount you receive when the property is sold and the amount you paid for it, if there has been an increase. 

You can deduct costs such as stamp duty and refurbishment. 

If, as suggested above, your wife owns the bulk of the property for income tax reasons, you could own 5pc in order to benefit from both of your capital gains tax allowances. 

Ms Brennan said: "Rather than the property just being in the wife’s name, it may be advisable that some beneficial interest is maintained by the husband, say 5pc, so that should the property be sold there is a capital gains tax saving. 

"As a married couple you would need to make an irrevocable declaration that income is to be taxed on beneficial ownership and not shared equally between them as it otherwise would be."

Inheritance tax

Given your current situation and plans, the total estate is unlikely to attract inheritance on your deaths - assuming no large lifetime gifts in the past, as your estate is under the current nil rate band for married couples, which is £650,000.

If your own home or the buy-to-let property was worth more, or you owned several buy-to-let properties, a trust might be more suitable, as it would take the property out of your estate for inheritance tax purposes. 

By 2020 a married couple will be able to pass on assets worth £1m to their direct descendants if this includes their main home. 

If the value of your house increases and the nil-rate band stays the same, then your daughter would benefit from a tax free uplift in the value of your main home when she inherits it.

olivia.rudgard@telegraph.co.uk

 

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