Inheritance tax on property
As a landlord or property investor, you want to ensure that your income-generating properties remain in your family for generations to come.
You also want to be able to continue receiving the income generated by these properties up until the point of your death.
However, one of the biggest concerns you might have is how to protect your property wealth from Inheritance Tax (IHT).
In this blog post, we will discuss some strategies for avoiding IHT on property and other assets.
Tax Planning Strategies for Property Investors
The most effective way of avoiding IHT is through tax planning. There are a number of different strategies available which can help reduce inheritance taxes on property investments, such as making use of trusts, gifting assets and taking advantage of tax reliefs such as Business Property Relief (BPR).
Trusts
Trusts can be used as a way to protect assets from IHT without losing control over them in your lifetime. With a trust, assets are held by trustees who manage them in accordance with the terms set out in the trust deed and distribute any income or capital gains arising from them according to the wishes of the settlor, the person setting up the trust.
Using trusts can be beneficial for landlords as it enables them to pass on their properties and other assets while still retaining control over them during their lifetime and passing on ownership only after they die.
Example: Transfer to a Discretionary Trust
This is an option but beware of the following limitations:-
First, the asset must be held in the trust for at least 7 years to fall outside of the estate for IHT purposes.
If there is a mortgage, permission from the lender is required, which may be difficult to obtain.
Additionally, only £650,000 per married couple can be transferred tax-free, with excess taxed at a 20% rate. A further £650,000 can then be transferred after 7 years and so forth. For someone wishing to transfer say a £1m portfolio, this would require them to survive at least 14 years to eliminate the IHT.
Capital gains tax can be deferred, but the original purchase price will still be used to calculate CGT when the property is sold. This however is merely kicking the can down the road for your children to deal with. If your children wish to sell the property, they would face CGT based on your original purchase price.
Rental income profits in a trust are taxed at 45%
There are IHT exit charges and a 10-year IHT charge on the assets held by the trust.
Finally, the trust must register with HMRC and file a Trust Tax Return each year, and the grantor cannot receive any income from the property if they wish to avoid IHT.
Gifting Assets
Another way landlords can avoid IHT is by giving away part or all of their assets during their lifetime. This includes giving away money or even transferring ownership of property into somebody else’s name. If done correctly, this can significantly reduce an individual’s estate value and thus reduce the amount payable in Inheritance Tax at death. It is important however that any gifts should be made at least seven years before death otherwise they may still form part of an individual’s estate for IHT purposes.
Gift property to your children
Gifting a rental property to your children can have consequences that must be considered. These include:
An immediate charge to Capital Gains Tax based on the market value at the time of the gift, which must be reported and paid within 60 days.
A loss of rental income, as the gift recipient cannot pay the gift giver any rent without it being deemed a gift with reservation and included in the gift giver's estate for IHT purposes.
A need to survive for 7 years for the asset to fall outside of the gift giver's estate for IHT purposes.
Potential tax implications for the gift recipient, who may be pushed into a higher tax bracket or already be a higher rate taxpayer.
Limited protection for the assets from potential claims by future partners of the gift recipient in case of divorce.
Difficulty obtaining permission for transfer if there is a mortgage lender in place, which may limit the gift giver to properties without mortgages.
Overall, gifting a rental property to children may not be the best option for reducing IHT and should be considered carefully.
Business Property Relief
Landlords may also be eligible for Business Property Relief (BPR) which allows certain business-related assets including investment properties to be passed down free from IHT up to certain limits depending upon their circumstances. To qualify for BPR a particular asset must meet certain criteria such as being held exclusively for business purposes rather than personal use . For example, holiday homes would not usually qualify for BPR whereas normal buy-to-let properties would normally qualify if all other criteria are met.
Avoiding inheritance tax on property investments is possible with careful planning and implementing strategies like using trusts, gifting assets, and taking advantage of tax reliefs like Business Property Relief (BPR). These strategies require expert advice so it’s best speak with a professional financial advisor who has experience helping landlords protect their property wealth and avoid inheritance taxes when it comes time to pass down those investments. By taking steps now you can ensure that your properties remain in your family’s hands long into the future while avoiding high rates personal tax on your income generated by those same investments when you pass away one day.
Freezer shares
You should consider a form of planning using “freezer” shares. The intention is to freeze the value of the shares belonging to you so that future growth in value accrues to their intended beneficiary – typically the next generation.
This is achieved by altering the company’s Articles of Association to divide the company’s shares into two classes, A and B shares. The A shares carry an entitlement to dividends and/or capital on winding up equivalent to the current value of the company and are retained by you. The important thing to note here is that when incorporating the company, your current value is equivalent to the nominal value of your A shares. i.e. £1 per share as there are no other assets in the company.
All future growth in the value of the company will accrue to the B shares which will be given to your children or perhaps to a trust that benefits succeeding generations. At this point, there should be no IHT implications inherent in this planning. The new B class of shares will have only a nominal value as initially they have no voting rights, no dividend rights and no capital value above their face value. There has been no significant transfer of value because the value of the existing shares is not substantially reduced. On your death, you will be taxed only on the value of the company at the date the two share classes were created.
The same approach can also be used where you have already acquired properties. In this case, a valuation would need to be carried out first to ascertain the current value of your shares.
Take advice now
Prior to making a decision on whether to purchase a property under your individual name or through a limited company, it is crucial to learn how to prevent paying inheritance tax on buy-to-let (BTL) property. This will prevent you from being stuck with undesirable options later in life. Contact us today to speak with our experts.
If you are serious about protecting wealth, please get in touch on via tax@mirandusaccountants.co.uk or online.
