Buying a Property and Maintaining it with a friend

Introduction

Buying a property in the UK can be a significant financial endeavour, and many individuals are exploring co-ownership options, such as purchasing property with a friend. While this arrangement can offer several benefits, it also comes with its own set of tax and legal implications that both parties should consider carefully. Over two articles, we aim to delve into the key factors to be aware of when both purchasing and maintaining a property with a friend, and the implications when it comes time to eventually sell the property.

Legal Structure

One of the first decisions to make when buying a property with a friend is the legal structure of ownership. There are three common options:

a. Joint Tenancy: In this arrangement, both owners have an equal share of the property, and if one owner passes away, their share automatically transfers to the surviving owner.

b. Tenants in Common: This allows for unequal ownership shares, and each owner can specify what percentage of the property they own. In case of death, the deceased owner’s share is not automatically transferred but is passed according to their will or intestacy rules.

c. Limited Company (LTD): Some opt to create an LTD to buy the property jointly, offering liability protection and clear rules for property management. A LTD has a legal concept called perpetual succession, this entails that the entity continues indefinitely despite the death, retirement or exit of any owner. This concept allows for shares to pass between individuals without the need for a property sale or change of deed although if the property is considered ‘high value’ (currently £500,000) you need to be mindful of the Annualised Tax on Enveloped Dwellings (“ATED”).

Financing the Property

Deciding how to finance the property is crucial. Both parties should decide how much each will contribute to the purchase price, deposit, and ongoing mortgage payments. A written agreement outlining these contributions and responsibilities is advisable to prevent disputes later.

Depending on intended use of the property, the individuals may wish to pursue differing types of mortgages in order to achieve their desired goals for their investments. The two most common types of mortgages are:

• Repayment mortgage (repayment of capital borrowed + interest)
• Interest only (paying back only the interest on the capital borrowed)

As the payments in relation to the equity of the property (i.e., capital borrowed) are not deductible for taxes, individuals who are wishing to pursue letting the property, may wish to pursue an interest only mortgage. However, this comes with its own unique set of risks. It is advisable to consult a mortgage advisor in order to better understand which mortgage aligns with your personal goals.

Legal Agreement

To protect both parties’ interests, it’s advisable to contact a solicitor to draft a legally binding co-ownership agreement. This agreement should cover various aspects, including:

a. Ownership shares and responsibilities.

b. How ongoing expenses (e.g., maintenance, property taxes, and utilities) will be divided.

c. Procedures for selling the property.

d. What happens if one party wants to sell and the other does not.

e. Dispute resolution mechanisms.

Stamp Duty Land Tax (SDLT)

SDLT (or its devolved taxes equivalents) is a tax payable when purchasing property in the UK. When buying a property jointly with a friend, SDLT is calculated based on the total purchase price and the ownership share of each party. Be aware that there may be additional SDLT charges if either individual purchaser already owns property or is non-UK resident, or if a company is the purchaser.

Taxation on Income

Should you decide to let the property, profits will be subject to UK taxation and depending on the legal structure in which the property is held, the way in which profits will be subject to tax in the UK may differ.

For all unincorporated entities (individuals, sole traders and partnerships), the individuals will be subject to income tax on their share of rental income. Individuals with untaxed rental income above £2,500 a year are required to complete a self-assessment tax return in order to report rental income and revenue expenses incurred throughout the year.

For incorporated companies, the company will be subject to corporation tax on profits earned through the accounting period. Should the company be in a positive financial position, the shareholders may seek to withdraw funds from the company in the form of dividends. The individual must report these dividends on a self-assessment tax return, these are taxed at a lower rate than standard income. Many individuals therefore see this as a better avenue for managing their personal finances, however, limited companies come with their own set of costs and administrative burdens.

Capital vs Revenue Expenditure

Capital expenses are costs incurred in order to acquire, improve or enhance a capital asset, such as a property. As these costs are incurred while adding to the value of an asset, they are not an allowable expense for the calculation of income taxes and instead are used to reduce gains subject to Capital Gains Tax (individuals) or corporation tax (LTDs) when selling a property.

Revenue expenses, also known as operating expenses, are the costs incurred in the day-to-day operation of an asset. These costs include such expenses as repairs, insurance and service charges. As these costs are incurred in relation to the continuing generation of income from an asset, they are not considered to add to the value of an asset are thus allowable for income taxes.

Mortgage payments

Since 2020/21, relief received by individuals for interest costs incurred on the mortgage of a residential property is given as a basic rate deduction from your final tax liability rather than as an expense from rental profits. This 20% deduction is however restricted to the lower of an individual’s financing costs and profits earned. If profits earned was the lower of the two figures, then there will be an amount of unused finance costs that are eligible to be carried forward for the calculation of deductions for the following year. 

Incorporated companies may claim all interest costs incurred in the financing of the property as an expense for the calculation of profits subject to corporation tax. There is no restriction to the amount allowable. If the company has a trading loss in the year, this may be carried forward in order to offset profits subject to corporation tax in the next financial years.

Cost and Administrative Burden

Whilst there may be a financial incentive in renting out a property, there can also be a significant amount of costs and administrative burden associated with this.

Incorporated companies are required to file annual accounts and corporation tax returns. Individuals and unincorporated businesses are required to report their income through self-assessment tax returns. Whilst there is no legal requirement for a professional to prepare these, there are many laws and regulations which need to be strictly followed in order to provide an accurate report. It is therefore advised that an individual seek professional guidance on this as failure to report accurate figures can result in penalties and potential criminal proceedings. This professional cost comes at a further cost to the individuals.

In order to claim expenses incurred on the property, an individual must keep all supporting documentation (e.g., invoices and receipts) for 5 years and 10 months. Should HMRC decided to investigate your accounts or self-assessment figures, they will expect you to be able to produce this supporting information. Failure to do so can result in fines being imposed by HMRC.

Conclusion

Purchasing an investment property with a friend in the UK can be a viable option to enter the property market whilst sharing expenses. However, it’s crucial to navigate the tax and legal implications diligently. Seek legal and financial advice, draft a comprehensive co-ownership agreement, and stay informed about changing tax laws and regulations to ensure a smooth and mutually beneficial property ownership experience.

Confused and want to make sure you get it right? At Edge Tax, our team of experienced professionals is here to help you through every step of the business process. Edge Tax stands as your trusted ally for all your tax needs, we provide tailored advice and support, removing tax planning and compliance stress. Don’t hesitate to contact us for a free consultation to discuss your tax needs and discover how we can help you take control of your financial future.

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