Tax planning with property
Leading tax and legal experts agree that a family home should only form part of an inheritance tax planning exercise as a last resort. Wherever possible, it is usually preferable to look towards other asset classes when considering planning of this nature.
However, property values have risen considerably over the past 20 years and this means that more and more people are likely to be subject to inheritance tax (‘IHT’) due to the value of their property. Accordingly, where the family home represents the main asset of the estate, it cannot be easily ignored where inheritance tax mitigation is a priority.
Nevertheless, there are still opportunities for utilising the family home in IHT planning and options continue to be available although the requirements of each alternative may not suit everyone.
Where the property is the main ‘family home’
This section of the briefing note assumes that the homeowner(s) is/ are UK domiciled and that the family home is situated in the UK.
1. Co-ownership of the property
There are two ways of holding property jointly – as joint tenants or as tenants in common.
a) Joint tenants
The owners own the whole of the property together and each is deemed to have an equal share.
On first death, the deceased’s interest passes automatically to the survivor and cannot be bequeathed under the deceased’s will. For IHT purposes, there will be a transfer of value of half the value of the property although if the couple are married or in a civil partnership, this transfer will be exempt.
A joint tenancy can be severed during the owners’ lifetime to create a tenancy in common. Subject to the agreement of relevant beneficiaries, a joint tenancy can also be severed retrospectively to make use of the nil-rate band on first death.
b) Tenants in common
The owners each hold a distinct share of the property, which can be unequal – for example to reflect each owner’s contribution to the purchase price.
Each tenant’s share is a separate item of property and can be disposed of during the owner’s lifetime or under the terms of their will. For this reason, tenancy in common is the most suitable way for co-owners to hold property from an IHT planning perspective.
In the absence of a will, the deceased’s interest in the property will be dealt with under the laws of intestacy. This can produce an undesirable result especially where couples are not married or civil partners.
When a co-owner dies, the IHT value of the deceased’s share in the property will be discounted by around 10-15% to reflect the restricted demand for the part shares in property.
2. Take out an equity release mortgage and gift the proceeds to children
Property owners may consider releasing equity may be released from the property in order to pursue an alternative strategy.
One does however need to bear in mind that, in most cases, the interest arising on the debt incurred rolls up during the life of the loan and is added to the principal debt. As a rule of thumb the compound effect is to double the debt during a 10 year period. The alternative strategy pursued with the capital released, or the benefit to the recipient if given away, needs to outperform the effect of the pooled up interest, taking account also of the potential saving of IHT.
3. Gift the home to your children (in the hope of surviving 7 years) but then lease it back at full rent.
One of the main obstacles in relation to the property is the general principle that in order for a gift to be effective for IHT purposes, the person making the gift must not continue to derive any benefit from the asset given away, or pay a market rent for the continued use and enjoyment. This principle is commonly referred to as a “gift with reservation of benefit” (the ‘GWR provisions’).
There are certain statutory exemptions from the GWR provisions. Some lifetime IHT planning arrangements make use of these exemptions, however, their application is fairly limited.
a) Gifting property and paying market rent: The market rent or ‘full consideration’ exemption applies where an individual makes an outright gift of the home but continues to live there, paying the donee the full market rent.
b) Gifting a share of the property with co‑owners sharing residence: In the co-ownership exemption, a share in the home is gifted absolutely and the donor and donee live in it together as their main residence with each also contributing proportionately to the running costs.
4. Home reversion and investment bond combinations
This type of arrangement is a relatively new concept. It involves the sale of the property to an insurer in exchange for a rent-free lifetime lease and a cash lump sum. The lump sum can then be used to purchase an investment bond linked to a fund that comprises all of the properties the insurer has purchased to date. The bond is normally gifted to the client’s heirs.
The bond provides a death benefit initially in the region of 90-95% of the property value. This may rise or fall with the value of the property fund. On death, the family are offered the opportunity to buy back the property at the open market value.
5. Downsize and unlocking capital by moving home
By downsizing, coupled with the release of capital (discussed at point 2 above) the options become more varied and include the possibility to make outright gifts of capital to intended beneficiaries which, after a period of survival of 7 years, fall out the charge to IHT on death. In addition it creates the possibility of implementing a Discounted Gift Trust arrangement whereby a right to income is retained from the capital gifted into trust for the beneficiaries.
Investment property – where this is not the principal place of residence
Gifting property into a lifetime Settlement
Property owners may wish to consider gifting their interest in a property to a lifetime Settlement. On the basis that the Settlor of the property survives seven years from the date of the gift to the Settlement and that the amount of their interest is below the nil rate band (currently £325,000), then there will be no charge to IHT. However, property owners must be aware of the ‘gift with reservation of benefit rules’.
In order for a lifetime gift to be fully effective for IHT purposes, the donor must give the property away without any strings attached. If the donor retains a significant benefit or enjoyment in the property given away, it will remain part of his or her estate for the purposes of calculating IHT.
The rule is that the property must be enjoyed to the “virtual exclusion” of the donor. As a result, there is some scope for a very minor reservation of benefit, such as the donor paying social visits or staying temporarily at a house given away.
There are various capital gains tax (‘CGT’) reliefs that may also be applicable which would avoid an immediate charge to CGT.
On the basis that the property being gifted to the Settlement has no mortgage attached to it, there will be no charge to Stamp Duty Land Tax on the transfer of this into trust.
Additional considerations for the non-UK domiciled individual owning property abroad
Excluded Property Trusts
An excluded property trust (‘EPS’) is an offshore trust that has favourable inheritance tax treatment. This favourable treatment usually applies where an individual, who is not deemed domiciled, creates an offshore company with non-UK situs property, the shares of which are held by an offshore trust. Please note that there are further issues that would need to be considered if beneficiaries of the trust then occupy the property with the need for licenses.
In order to qualify as excluded property there are two tests, both of which must be satisfied:
1) The settlor must have been domiciled outside the UK at the time the settlement was made (or at the date of any additions, if the added property is material). Deemed domicile (see above) applies for this purpose.
2) The property in question must be situated outside the UK at the date of the charge to IHT.
An EPS is a useful estate-planning tool, which may help with the orderly distribution of assets to family members or other beneficiaries. Also, as trustees are the legal owners of the underlying assets, an EPS may provide particular benefits where assets are held in jurisdictions where forced heirship applies, and may offer protection against seizure of assets.
For inheritance tax purposes, foreign situs property is “excluded property” and, therefore, outside the ambit of IHT provided the settlor had neither an actual nor a deemed UK domicile when the settlement was made. The settlor’s domicile is tested solely at the time the settlement is made. Accordingly, it is immaterial if the settlor subsequently acquires an actual or a deemed UK domicile. So too, the domicile or deemed domicile of the other beneficiaries is irrelevant.
However, the settlor should not in any way add to the settlement if they acquire an actual or a deemed UK domicile. If this is the case, HMRC may argue either that the addition is a separate, non-excluded settlement or, if the funds have become intermingled, that the whole settlement has lost excluded property status.
Capital Gains Tax
The reason why an EPS brings CGT advantages is that gains in the trust are not subject to CGT as they arise, provided the trustees are not resident in the UK and the settler is not domiciled in the UK. This is so whether the gains arise on UK or on foreign situs assets.
CGT consequences of having deemed domicile for IHT purposes
As the concept of deemed domicile does not figure in the CGT code, the CGT advantages of a non-resident settlement may be attained even if the settlor is deemed UK domicile for IHT purposes, provided they retain actual foreign domicile as a matter of general law.
The income of an EPS is treated as the settlor’s notional income and is taxable on an arising basis, unless the remittance basis is available.
This attribution of income is, however, subject to the remittance basis (if available). The income arising is referred to as ‘deemed income’. If that deemed income would be treated as relevant foreign income if it were the settlor’s, then it will be taxable if brought to the UK as a “remittance”.
Please note that legislation is being published in December 2012 which is likely to alter the way in which EPS’ work for residential property worth over £2million. We will be looking into this further in due course.
Advice on property holding and transactions depends on whether you are an investor, trader, or developer, and whether your property is commercial or residential, in the UK or overseas.
In addition to the above, we offer, for example:
- Advice on tax efficient property holding vehicles
- Advice on tax deductible costs and expenses
- Capital allowances planning, including advice as to whether expenditure constitutes repair or capital improvement expenditure and advice on the tax implications of each
- Stamp Duty Land Tax planning
- Capital gains tax planning, including advice on the investment or trading status of the property business and the potential for claiming capital gains Entrepreneurs’ relief, holdover relief for gifts, or rollover relief on reinvestment of sale proceeds into new property acquisitions
- Tax advice on the favourable income and capital taxes reliefs available for furnished holiday letting accommodation, and advice on structuring to achieve those reliefs
- Advice on tax efficient investment in overseas property
This briefing is for guidance purposes only. RadcliffesLeBrasseur accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.