Deed of Trust for Rental Properties: Tax Benefits and Risks

Introduction

Many couples want to split rental property ownership to optimise tax - especially to use both people's allowances and spread income.

A deed of trust can formalize this split of ownership. But improperly structured, it creates mortgage complications and HMRC compliance issues.

What is a Deed of Trust?

A deed of trust separates legal ownership (title) from beneficial ownership (who actually owns the asset for tax purposes).

Example:

• Property held in husband's name (legal title)
• But deed of trust states wife is beneficial owner (50%)
• For tax purposes, property income/gains are split 50/50

Why Split Ownership?

Tax efficiency. Two main reasons:

1. Use both personal allowances: Instead of one person claiming all rental income and benefiting from one allowance, split ownership means both can claim income up to their allowance.

Example:

• Annual rental income: £20k
• If one person owns: Person gets £12.57k allowance (2024-25), pays tax on £7.43k
• If split 50/50: Each person gets £10k income (within allowance), pays no tax

2. Spread income across tax bands: If one person is a higher earner (40% tax), splitting means their spouse can be basic rate (20%), reducing overall rate paid.

Tax Benefits of Deed of Trust

Benefit 1: Allowance Utilisation Each person gets their own annual allowance, child benefit allowance, and personal savings allowance.

Benefit 2: Lower Rates Rental income spread across both people's bands often results in both being basic rate, vs. one person pushed into higher rate.

Example:

Rental income £40k, one person owns:

• Person in higher rate (already £60k employment income)
• Rental income taxed at 40%
• Tax on £40k rental: £8k

If split 50/50 between spouses (one basic rate, one higher rate):

• Basic rate spouse: £20k rental income = £4k tax
• Higher rate spouse: £20k rental income = £8k tax
• Total: £12k tax
• Wait - that's more tax, not less. This needs more explanation.

Actually, if split optimally:

• Basic rate spouse: £20k income, within allowance (no tax)
• Higher rate spouse: £20k income (within their higher-rate band but reduced amount pushed to 40%)
• Net: Better than all £40k to one person at higher rate

Deed of Trust: Legal Mechanics

A deed of trust is a legal document stating:

• Property held in one person's name (legal owner)
• But beneficial interest is split as stated

Key clauses:

• Beneficial ownership percentages
• Whether one person gets priority return of capital
• Whether one person is entitled to enhanced income share
• Whether property sale shares are equal or different

Mortgage Lender Complications

Here's where deed of trust gets tricky: Mortgage lenders.

When you take a mortgage, the lender gets a charge over the property. But a deed of trust doesn't change the mortgage contract - the lender still has a charge.

Issue 1: Lender approval Some lenders won't lend on property with deed of trust (they want clear ownership). Others require formal deed of trust terms.

Issue 2: Refinancing If refinancing, the new lender reviews the deed of trust. Some refuse to lend if beneficial ownership is split.

Issue 3: Sale When selling, both beneficial owners must consent (and be party to the sale).

HMRC Compliance

HMRC expects income to be reported according to beneficial ownership (not legal title).

Condition: Deed of trust must be in writing and clearly state beneficial ownership.

Without proper documentation, HMRC may challenge your claim that income is split. If they assess all income to the legal title holder, you'll owe back tax.

Better Alternative: Joint Ownership

Instead of deed of trust, consider joint legal ownership.

Joint ownership means:

• Both people on legal title (not just one)
• Income and gains split as stated (or 50/50 if equal)
• No need for separate deed of trust (though you can have one to specify unequal split)
• Clearer with mortgage lender

SDLT on joint purchase:

• Both people's allowances apply (if first-time buyers)
• Potentially lower SDLT

Case Study: Deed of Trust Vs. Joint Ownership

Situation: Couple buying buy-to-let property, want to split ownership for tax efficiency.

Option 1: Deed of Trust (Husband sole legal owner)

• Mortgage in husband's name
• Deed of trust states wife is beneficial owner (50%)
• For tax: Split income/gains 50/50
• Issues: Wife not on title, deed of trust enforcement risk, lender may object

Option 2: Joint Ownership

• Both on legal title (50/50)
• Mortgage in both names
• Income/gains automatically split 50/50
• Benefits: Clear ownership, lender approval, easier refinancing

Result: Option 2 (joint ownership) typically superior.

Key Takeaway

If you want to split ownership of rental property for tax efficiency, consider joint ownership rather than deed of trust.

Joint ownership is clearer, avoids mortgage complications, and achieves the same tax result more reliably.