Inheritance Tax planning for residential property

The increase in UK residential property values over recent decades has been rapid, and the Inheritance Tax (IHT) tax-free allowance (the amount allowed before you pay 40% tax on the remainder of your estate at death), has not kept pace.

The IHT nil rate band has been frozen at £325,000 since 2009 and is set to remain so until at least 2028. Although the more recent introduction of an additional residence nil rate band (also frozen until at least 2028) of £175,000 helps for those who qualify, these figures have not kept pace with property values. Those with property portfolios are even more exposed to significant liabilities but there is unlikely to be the cash available in the estate to pay the tax. There are, however, steps that can be taken to plan for the tax payment and to mitigate that potential large liability.

A helpful calculator can be found here.

Wills

The first thing to consider is who you want to inherit your property portfolio. For this, it is important to have an up to date will, to make this clear on your passing, but in doing so, you should consider the potential IHT implications of your decisions. Many people will pass their estate onto their spouse or civil partner if they are the first to decease, and this takes advantage of the unlimited IHT spousal exemption, assuming the surviving spouse is UK domiciled. However, this will only defer the looming IHT bill until the second spouse dies, when property prices may have increased further.

If the ultimate goal is to pass wealth down to your children or grandchildren on death, this will be subject to IHT at 40%, subject to the main and residence IHT nil rate bands. On the second death, i.e., the death of your spouse, any unused nil rate band from the first death’s estate can be utilised, which can lead to a potential combined nil rate band of £1m. However, the residence nil rate band can only be used against a property that has been used as a residence during the period of ownership.

Even with a tax efficient Will that can defer the tax until the second death, the tax still needs to be paid. It is possible that the tax on some of the assets can be spread over 10 years, but with interest. Often, where affordable, a life insurance policy is considered as an option to pay the tax to avoid the need to sell or mortgage of property.

Gifts during lifetime

To mitigate the size of your estate before death, you can gift property to your potential beneficiaries during your life. Such gifts can usually be transferred free of IHT provided you survive more than 7 years from the date of gift. There are also reductions in the value taxed on your estate after 3 years. 

The position is complicated if you still live or use the property in question after you have gifted it. However, with careful planning, there are steps you can take to make gifting an effective means to reduce your estate. This includes paying a market rent for your continued occupation of the property or retaining a share of ownership of the property yourself and gifting the rest.

The position is simpler where the property is a rental property and you decide you want to gift it, and hence the rental income, to the beneficiary.

Unfortunately, the act of gifting property does not come free of tax. The key tax to consider is capital gains tax (CGT) on any gain arising between date of acquisition and you giving the property away. Stamp Duty Land Tax (SDLT) may also be applicable, particularly if there is still a mortgage on the property. However, with careful management of liabilities, gifts may still prove more tax efficient in the long run. For more modest gifts of property, typically with value of up to £650,000, a trust structure can be considered so that the gain for CGT purposes is not triggered.

Alternative structures

Owning property is by no means restricted to personal ownership, and you may already hold some or all of property portfolio in a company or trust structure. 

Typical structures we see and advise on are:

• Discretionary trusts
• Family Investment Companies.

From an IHT perspective for a company, it is important to understand who holds the shares as the value is likely in their estate for IHT purposes. Changing the shareholders may be appropriate. You may already have some IHT efficiency within your existing structures, although these should be regularly reviewed.

Many use these structures because they are concerned about the risks in gifting property outright to your children or grandchildren, like divorce or bankruptcy. A structure like a family investment company or new trust to retain some control of the assets, whilst still reducing your estate for IHT purposes can be attractive. 

Alternative structures do sometimes come with other taxes that you need to consider, both for existing and new structures. These include other IHT charges applicable to trusts, and corporation tax on companies. Companies also need to consider Annual Tax on Enveloped Dwellings (ATED) charges where they hold a UK residential property valued over £500,000, although there is no tax charge if the property is commercially let.

There are a number of ways you can structure or gift your property portfolio in order to mitigate the IHT liability on your estate at death. It is important to do this sooner rather than later, as early planning can lead to sizeable reductions in the liability, which in turn means you can pass on more of your estate to your beneficiaries.

If you have any questions about the topics raised in this article or to discuss your individual circumstances, please get in touch with David Conway, or your usual Crowe contact.