23 March 2018
It is common for spouses to purchase their home without receiving tax advice. Ownership in real property seems like a straightforward and simple transaction to most people. Most spouses believe that they both love each other, and they will always love each other, so why not simply own their home as joint tenants? The lawyer’s answer is that it is rarely this simple, particularly if there is a diversity of citizenship and/or fiscal status amongst the spouses. In these instances, the purchase of real property as joint tenants can result in a tax disaster.
For example, say a US citizen and a UK citizen purchase their London flat as beneficial joint tenants. Under these circumstances, unwittingly the US citizen may be making a gift to his spouse which may result in a US federal gift tax being owed unnecessarily. The US federal gift tax would be owed either on the purchase or, more commonly, on a later sale of the home.
If the home is sold, in addition to a potential for US federal gift tax being paid on the sale, the US citizen may also owe US federal income tax. This is because, subject to certain limitations, a US citizen can only exclude up to $250,000 of gain from tax on the sale of his or her main home. The UK, however, offers relief from taxation which can exempt from tax the gain arising when a UK resident sells their home. This can result in substantial US tax being owed on the gain where none is due in the UK.
Additional US federal gift tax and income tax is bad, but what if there is no later sale? If the US citizen dies while owning the home and is survived by his UK spouse, the full fair market value (not half of the value) of the home will be included in his taxable estate for US federal estate tax purposes, unless the UK spouse can prove that she contributed to the purchase (typically not easy to prove). In this instance, the full value of the home may be subject to US federal estate tax, and then may also be subject to UK inheritance tax when the UK spouse dies. This mismatch can result in double taxation of the home. If the home is bequeathed to the UK spouse in a special trust (a Qualified Domestic Trust or QDOT), the transfer should qualify for both a marital deduction in the US and spouse exemption in the UK, avoiding double taxation.
With US federal estate and gift tax rates at 40%, and US federal income tax on capital gains reaching rates in excess of 20%, it is very important for spouses to plan carefully when deciding how to purchase their English castle.