Inheritance taxes for owners

Some advisers claim that by taking a series of steps planned in advance, the value of a property company’s shares is completely sheltered from inheritance tax (IHT).

When something seems too good to be true…

Unfortunately, the reality is that property held personally, in a trust or in a business will be subject to IHT. Of course, with a Labor Budget on October 30, IHT could be increased. There is also speculation that the tax-free increase in capital gains on death could also be removed, meaning there would effectively be a “double tax on death”. This could mean that a gain on a rental property is effectively taxed at just over 54%.

So what can you do to protect yourself against IHT changes? This will depend on how the properties are held.

Incorporate your real estate business

If a number of properties are operated as a business, you may consider incorporating the business. Incorporation Relief should be available so that there is no capital gains tax to pay and the company takes over the properties at current market value. Land stamp duty would however be payable, although this could be reduced by applying SDLT commercial rates where six or more properties are transferred.

You can then consider giving shares directly or in trust to members of your family. This could trigger capital gains tax, but currently the maximum rate of CGT on shares is 20%. The value of the donated shares will be out of your estate after 7 years.

You can also create growth stocks that only participate in future growth in value over a predetermined minimum rate. With careful planning, HMRC should accept that these shares have little value on issue.

Where properties are owned by an existing partnership, incorporation can take place without SDLT being payable.

Alternatively, you can simply ‘sell’ the properties to your own limited company. Yes, it will create capital gains tax and SDLT bonds, but it “cashs in” them at current rates. It would be necessary to do some math to calculate what the overall effective tax rate is.

The advantage would be that this would create a significant credit on the director’s loan account. You can immediately gift all or part of this to your children. This would be a Potentially Exempt Transfer (PET) and out of your estate after 7 years. Even if you “donated” the loan account (or part of it), your children can only access the funds at your request.

Form a real estate partnership

Forget about forming a partnership to build up later. The SDLT’s extensive anti-avoidance rules mean that at the time of incorporation, SDLR relief will not be available.

Instead, it is possible to form a partnership with family members entitled to a future share of the growth in property values. With care, this can be achieved without any tax costs and will mean that the majority of future growth in value will not fall within your estate.

Direct gifts of goods to your children

You can make outright gifts of goods to your children. There will be no SDLT to pay but there will be capital gains tax to pay on any increase in the value of the property since acquisition. Any gains must be declared to HMRC and tax paid within 60 days of completion.

Using a family trust

The capital gains tax payable on direct gifts of property may make this option unattractive. As an alternative, you might consider using a trust. The transfer into the trust is a chargeable lifetime transfer, so any transfer worth more than £325,000 (£650,000 for a married couple) would incur a 20% lifetime IHT charge. However, because this is a gift in trust, any capital gains can be withheld, meaning the trust effectively takes care of the original cost basis of the property.

At a later date, the property can be transferred out of the trust to your children and, again, the gain can be retained. This means that the trust can serve as a “stepping stone” to indirectly pass properties to children without incurring capital gains tax.

I will stay alone…

You can of course choose to do nothing and see what the budget brings. Nothing may change, although it seems increasingly unlikely.

Next steps

If you would like to know more about protecting the value of shares in a property against IHT or would like to find out more about outright gifts of assets to your children, contact us.