The Private Residence
There are normally no capital gains tax issues if you gift the family home during your lifetime. This is because any capital gains that may arise is normally covered by something called private residence relief and so no tax needs to be paid to HMRC.
Provided the doner survives 7 years from making the gift it will fall out of their estate for inheritance tax purposes (taper relief applying from year 3-4 -see IHT basics). This can be a particularly efficient way to reduce IHT on death.
However, problems can arise if the person making the gift wishes to continue to occupy the property and thus benefit from it after transfer. The “gift with reservation of benefit” (GROB) provisions may apply and so it will still be treated as part of your estate on death as it is not truly gifted in the eyes of HMRC.
For those with surplus net income one of the simplest ways to avoid the GROB provisions and benefit from an IHT saving is to pay commercial market rent for occupying the property once gifted.
However, care needs to be taken to ensure a formal rental agreement is in place with a commercial “arms length” rent being paid for the property. The rental charge will probably also need to be increased over time.
However, this may not be appealing to those that don’t have the surplus income to pay market rent on a property that was their former home. In particular, if they are in ill-health and unlikely to survive the seven year gift period – as this could result in a total loss of the RNRB with little or no reduction in the amount charged to IHT on their death.
Alternative – “Co-ownership”
One alternative may be to gift the ownership of part of the property to your adult child via a trust arrangement if they live with you. Provided the child pays a fair share of the outgoings of the property it will not give rise to a GROB charge.
For this planning to work it is important that the doner retains a sensible interest in the property and pays their fair share of running and maintenance costs.
We can help you explore this option should your circumstances fit and explain the benefits of being able to discount your remaining interest held for IHT purposes as well as being able to potentially utilise the RNRB on death.
Family Investment Partnerships
If you operate a number of rental properties as an investor or jointly with your wife, one opportunity for you to introduce your children into the business would be to form a family investment partnership.
At the outset you could gift a small percentage of capital in your properties that does not trigger a capital gains tax charge. This could be done via a “deed of gift” and then a partnership agreement could be constructed and entered into.
For inheritance tax purposes the gift of capital will be a “potentially exempt transfer”. Therefore, provided you survive 7 years from making the gift it will fall out of your estate for inheritance tax purposes (taper relief starts to apply from the end of year 3).
On death (or death of the surviving spouse for jointly held property) you will not own 100% of the rental properties you have transferred into partnership. This would mean that the asset valuation for the deceased’s estate could not be at full market value of the rental properties. In essence, for a very small gift (that you could increase over time) you could substantially reduce the value of the rental properties for inheritance tax purposes but continue to enjoy the majority of the profits.
Partners can on occasion decide to share partnership profits in a different proportion to their capital contributed. Especially if your children will be proactive in the business and spend a significant amount of time helping you run it. This can have advantages with income tax planning.
Using a trust to pass property tax efficiently to children
If you outright gift a rental property to your adult child it can trigger an unwanted capital gains tax bill of up to 28% on the difference between what you paid for the property and market value of it on the date of gift. This can put most Landlords off gifting rental property in their lifetime.
However, transferring a property into trust with your adult child as beneficiary can have the desired affect for inheritance tax planning purposes whilst deferring any potential capital gains tax charge that would be due.
Transferring a property into trust will trigger an immediate inheritance tax charge on the doner as it is classed a chargeable lifetime transfer. However, each person has a nil rate band of up to £325,000 they can utilise before any IHT is payable. Gift holdover relief can be claimed on the property being transferred into and eventually out of trust for your child. Provided the trust is operated for a specific period of time your child can be appointed the property absolutely at some point in the future. Provided you survive 7 years from the date of the gift it will fall out of your estate for inheritance tax purposes. Your nil rate band will also reset after 7 years and can be utilised again. For joint owners of property, up to £650,000 can be transferred into trust without triggering an IHT charge. Once the child is appointed the property absolutely the capital gains tax base cost is the price that you paid for the property.
Please see our case study in “Using a trust for IHT planning” to view an example.
Other items to consider
There are a number of reliefs and exemptions you can make use of to ensure you don’t pay inheritance tax on your estate where possible. Some of these include:
Annual exemption – Each person can gift up to £3,000 worth of assets each tax year which will be exempt for inheritance tax purposes. You can also make use of any unused allowance from the previous tax year. Therefore, for a couple who haven’t made any gifts recently they can give up to £12,000 free of inheritance tax.
Gifts out of regular income – If you have surplus income you may consider making regular gifts to say grandchildren which will be exempt for Inheritance Tax purposes. There is no limit to the amount you can gift but it should not affect the standard of your living and be paid out of your earned income. You also have to establish a pattern of gifting over time. This can be useful for clients that may not survive 7 years from the date of the gifts.
Tax efficient investments – an independent financial adviser will be able to talk you through the various strategies that exist for clients that want to invest their money in IHT sheltered products and investments. Although we cannot advise you on specific products we can provide general advice on the tax treatment of these. We also have strong business relationships with local IFA’s and would be happy to put you in contact with a reputable provider for you to explore further.
If you are interested in seeing how we can help you and your property business with inheritance tax planning please get in contact with us today.