Anyone that’s been investing in property over a number of years, and is perhaps getting on in years themselves, will be beginning to think about the consequences of inheritance tax on their investment property and the impact this will have on their estate when it comes to eventual benefits for their loved ones.
It’s becoming an even bigger problem today as property prices rocket, particularly in some locations such as London and the south-east, pushing up the total asset value of people’s net wealth far beyond what was imaginable just a few years ago, and well beyond the recent paltry increases in tax allowances.
This is not meant to be financial advice and anyone contemplating making financial decisions or not regarding inheritance tax and giving should consult a qualified financial advisor first.
As a UK taxpayer you are currently entitled to pass on up to £325,000 (2013-14) of assets without paying any inheritance tax (IHT). With even average house prices now approaching this amount, let alone those higher house prices in sought after areas, and anyone with additional investment properties, tax liabilities at 40% can be astronomical.
Your heirs won’t thank you for burying your head in the sand and doing nothing about it until it’s too late. If you want to secure your children’s and your grandchildren’s future from your hard earned lifetime’s earnings, then perhaps you should start your tax planning now.
There are several options when it comes to passing on property wealth tax efficiently:
Giving it away now!
Your simplest option by far is to consider a lifetime gift. To gift your properties to your children now, so that the value of your estate is reduced, means that the gift must be outright to be effective.
If you live for 7 years after making a gift to someone, it’s exempt from Inheritance Tax regardless of the value. This is called a potentially exempt transfer.
This means giving up any right to receive rental income or a share in the proceeds of sale.
Any gift made in this way should be evidenced in writing and the Land Registry entry would then need to be amended. The value of any gift would be potentially liable for IHT if you die within seven years.
However, lifetime gifts will incur capital gains tax (CGT) on transfer. Any difference between the price you paid for the property and the market value at the time of the gift would be taxed. This tax rate varies from 18%, and can be as much as 28%, depending on the amount of gain and your current income.
Everyone has an annual exemption, so you can give away up to £3,000 a year – you can also carry over any unused allowance from the preceding tax year. These gifts will be exempt from Inheritance Tax when you die.
You also have a small gift exemption, so you can make small gifts of up to £250 to as many people as you like (but you can’t use this exemption with the £3,000 annual exemption for the same person).
There are also special wedding and civil partnership gifts. These are exempt, with certain rules, and currently:
- Parents of the couple can give them cash or gifts worth up to £5,000
- Grandparents can each give up to £2,500
- Anyone else can give up to £1,000
You will have to make the gift, or promise to make it, on or shortly before the date of the wedding or civil partnership ceremony.
Anyone with a business is entitled to business relief. If you own a business or share of a business you may be able to pass some of it on without paying tax. You will need professional advice here.
Giving a Part of a Property
It is also possible with property to give a part, which is known as part gifting. This is an alternative to an outright gift of all of the property. So, you would then be a joint owner with your children. The part-gifted property would be treated for IHT purposes as above, but this would allow you to continue receiving some of the rental income.
Every tax year more of the property can be gifted. This can be used to reduce the likelihood of a CGT charge, by limiting the capital gain realised to less than the available annual exemption. This is the amount of tax-free capital gains that can be made each year.
You can achieve a similar result, possibly with greater control, by use of what is known as a formal discretionary trust. For this you should seek professional advice from a good accountant or financial advisor who is qualified to advise on trust matters and bear in mind costs involved can be substantial, so unless you have a relatively large estate this method can be uneconomic.
Using Equity Release
Instead of gifting the property itself, another option is to release equity from the property by taking out a mortgage and then passing on the cash generated to children.
This could avoid CGT as the title to the property would be retained by you. However, the gift of cash could still potentially be liable for Inheritance Tax if you die within seven years.
In this case any mortgage taken out would be a deductible liability against your estate, reducing the value being taxed. If the property is being rented out interest on the loan would be paid from this rental income and the interest charge would reduce any taxable rental profit, saving you on income tax.