When it comes to property ownership, one of the most concerning issues for families is the impact of Inheritance Tax (IHT). Some advisers claim there are surefire ways to completely protect property shares from IHT through pre-planned actions. However, if something sounds too good to be true, it often is. Understanding the realities of IHT and how it affects property assets is essential for ensuring that any wealth built up over a lifetime can be effectively passed on to the next generation.
The Reality of Property and IHT
The unfortunate truth is that whether properties are held personally, through a trust, or within a company, they are generally subject to IHT. Moreover, given recent discussions about upcoming government budgets, there’s a chance that IHT rates might even increase. Additionally, there’s speculation that the capital gains tax (CGT) tax-free uplift on death could be removed, which would create what amounts to a “double death tax”. For example, this could mean that a gain on a buy-to-let property may be taxed at rates of over 54%.
With these potential changes, it becomes more important than ever to consider the available strategies to protect property investments. The appropriate approach will depend largely on how the properties are held, and each method carries its own pros and cons.
Incorporating Your Property Portfolio
If you own several properties and manage them as a business, one option to consider is incorporating the business. Incorporating a property business offers several tax benefits. Through Incorporation Relief, you can transfer properties into a company without incurring immediate CGT, provided the properties are moved at their current market value. However, Stamp Duty Land Tax (SDLT) would still apply, although a reduced rate may be available if you are transferring six or more properties and can therefore qualify for commercial rates of SDLT.
Once the property portfolio has been incorporated, there are options to consider reducing the future IHT burden. One such approach is to gift shares in the newly incorporated company to family members, either outright or into a trust. This would trigger CGT, but the current CGT rate for shares is capped at 20%. After seven years, the gifted shares fall out of your estate, reducing the potential IHT liability.
Alternatively, you can issue “growth shares”. These growth shares only participate in the future growth in value over a predetermined base rate. Careful planning can ensure that these shares are assigned a minimal value when they are first issued, allowing them to be passed on without significant tax implications.
If your properties are already held in a partnership, then transferring them to a company may avoid an SDLT charge altogether, providing another tax-efficient route to incorporation.
Selling Properties to Your Own Company
Another approach to restructuring property ownership is to sell the properties directly to your own limited company. This option creates both CGT and SDLT liabilities, but it also “banks” these tax rates at their current level, potentially avoiding higher rates in the future. To determine whether this is the most effective route, a careful analysis of the overall tax rate would be needed to see if it makes financial sense.
A key advantage of this method is that the sale can create a substantial director’s loan account. This loan account can then be gifted, either partially or wholly, to your children. This type of transfer would be classified as a Potentially Exempt Transfer (PET), meaning it would fall outside your estate after seven years. Although you may have “given away” the loan account, your children can only access the funds at your discretion, giving you a degree of control.
Creating a Property Partnership
Some may consider forming a partnership as a prelude to incorporating their properties, but it’s essential to be aware of extensive anti-avoidance SDLT rules. These rules generally prevent SDLT relief on incorporation if a partnership is formed specifically to achieve this.
However, a family partnership can be effective. By forming a partnership that allows family members to benefit from future growth in the value of the properties, you can achieve a tax-efficient structure that ensures future appreciation falls largely outside your estate. This approach, when structured properly, can be achieved with minimal immediate tax cost.
Directly Gifting Properties to Children
Another route to consider is making outright gifts of properties to your children. This method comes with its own pros and cons. On the plus side, there is no SDLT payable when gifting property. However, any appreciation in the property’s value since you purchased it would be subject to CGT. This gain must be reported to HMRC, and the tax must be paid within 60 days of completion.
Using a Family Trust
If the CGT implications of directly gifting property seem too steep, a family trust might be a more appealing option. Transferring property into a trust is classified as a Chargeable Lifetime Transfer, meaning that anything over the nil rate band (£325,000 per individual or £650,000 for a married couple) would incur a 20% lifetime IHT charge. However, a key benefit of using a trust is that any capital gain can be held over, allowing the trust to assume the original value of the property.
Later, the property can be transferred from the trust to children, with the gain deferred once again. Effectively, this makes the trust a useful “stepping stone” to pass on property assets without incurring significant CGT liabilities, providing a tax-efficient pathway to transfer wealth across generations.
Final Thoughts
Inheritance Tax planning is a complex area, and with the potential for future tax increases, finding the right strategy is more important than ever. Whether it’s incorporating your property business, forming a family partnership, or making use of a trust, the ultimate goal is to structure your property ownership in a way that minimises the tax burden on your estate and protects your family’s financial future.
However, every situation is unique, and professional advice is crucial to navigate these options effectively. By planning ahead and understanding the tax landscape, property owners can ensure that their legacy remains intact, benefiting future generations without unnecessary tax burdens.
