This article is part of a series first published in eprivateclient in summer 2020, which considers these opportunities in more detail. Click below to read our other articles.
Part 1: The basics of estate planning Part 2: Making lifetime gifts to the next generation
Part 4: Giving to charity – good for the soul but what about tax?
For many, property is typically the largest taxable asset in their estate, therefore divesting themselves of some of this can result in substantial inheritance tax (IHT) savings. As with most gifts, there are tax implications, this time with the added problem of stamp duty land tax (SDLT). But again, these are often based on market value, so is now a good time to look at this?
Property investors have seen a good return in recent years with property values increasing and landlords seeing a decent yield compared to other investments. This has of course meant that the sector has been subject to scrutiny from HMRC, who have introduced a number of tax changes designed to burst the ‘property bubble’ and slow down the market. These include tax restrictions on interest deductions for individuals (companies are not affected), higher rates of capital gains tax (CGT) and SDLT surcharges.
What this means is that some private investors have considered alternative ways of owning property to mitigate some of these changes. This can include giving property away to family members who are paying tax at lower rates, or in many cases considering a corporate structure. This ensures the rental income is taxed at lower corporation tax rates, therefore increasing yield and also transfers value out of the donor’s estate for IHT.
While a gift to a child can seem like a good idea, as we have seen in our previous articles there are tax implications, as the gift has to be made at market value for tax purposes, which can result in a ‘dry tax charge’. That said, as values are lower at the moment, it may be that any gain is not significant so CGT is manageable.
For this gift to be effective, the donee must become absolutely entitled to the income and the capital asset to (virtually) the exclusion of the donor. Sadly, this means that rights to income cannot be retained if the gift is to be effective for IHT. Fundamentally, it also means that the child has the right to sell the property should they wish to do so.
On the plus side, a gift of an asset for no consideration is outside the scope of SDLT, this is unless the property is subject to a mortgage. In this case, if the donee takes on this debt then this will be treated as consideration and SDLT charged on the balance outstanding.
An absolute gift of property may not be right for many people, concerns over the reduction in disposable income or placing an asset of significant value in the hands of a young adult can be a daunting prospect. A Trust or a corporate structure may therefore be a better option.
A Trust enables assets to be given away and control retained by the donor as Trustee. Our next article will consider Trusts in more detail, but in terms of property investments they can be quite restrictive. They are efficient from a CGT and SDLT point of view however, depending on the value of the property there could be IHT charges on settlement. Also in the same way as gifts to individuals, it is difficult to retain an income or access to capital if the gift is to be effective for IHT.
For these reasons corporate structures often known as ‘family investment companies’ have become popular in recent years.
As with any tax question the answer is ‘it depends’. There are still tax consequences of transferring property to a company, CGT and SDLT are both at market value and while in some cases these can be mitigated, this is in very specific circumstances requiring careful planning.
There are though, a number of benefits:
The corporate structure works best where the founder does not need to access all the income from the investment and is happy to give away some of the capital. The structure is usually set up by a sale of the properties to the company, leaving the consideration outstanding as a loan to the founder. This can then be repaid gradually out of the rental income being earned in the company to supplement disposable income. To make this effective for IHT, some of this debt can be assigned to the other family shareholders. This gift is a potentially exempt transfer, falling out of the estate for IHT after seven years. Any growth in value attributable to the other shareholders is outside the estate immediately.
There is no one size fits all and careful consideration should be given to future income requirements before assets are given away. Property taxes are however broadly based on market values, therefore now may very well be a good time to think about this.