A major concern for landlords is how to avoid the Inheritance Tax on BTL property. When speaking to landlords, much like myself, they seek long term capital growth and to supplement their current and retirement income with a view to protecting the property wealth and passing on the assets to their children whilst avoiding high rates of personal tax on that income.
An overriding concern is that they wish to retain control over the properties during their lifetimes, so that they can carry on receiving the income but also ensure that the property wealth is protected for their bloodline and is not attacked by future partners of their children should they divorce. In the tax profession, Inheritance Tax is known as the tax of choice. You can choose to pay it or not pay it. By taking advice early or as soon as possible, an effective Inheritance Tax plan can be put in place to help you avoid Inheritance Tax and ensure your wealth can be passed
on to the next generation and protected for the generations to come. Here we take a look at the Inheritance Tax position of owning property in your personal name and through a limited company.
The do nothing approach or I will not be here so it does not affect me..!
On death, the net equity in your investment properties will be included as an asset in your estate for IHT purposes. For example, if you pass away leaving a portfolio valued at £2m on which there is outstanding debt of £1m your IHT would be 40% of £1m = £400,000. You do get a £325,000 nil rate band which can go up to £500,000 if you are leaving your main residence to your children and grandchildren. This can go up to £1m for married couples but for our purposes, we have assumed that these nil rate bands will have been used up against your main residence. It does not take much these days for you to have your own home worth more than £650,000.
Gift property to your children
A gift of any of the rental properties can be made to your children at any time. The consequences however would be:-
• An immediate charge to Capital Gains Tax as the transfer value is always deemed to be at the market value at the time of the gift. This will now have to be reported and paid within 60 days.
• A loss of the rental income. Once gifted you can no longer receive any of the rental income otherwise this would become a Gift with Reservation and would fall back into your estate for IHT purposes.
• You would need to survive for 7 years for the asset to fall entirely out of your estate for IHT purposes.
• Your children may not wish to have ownership in their personal names as the income would push them into a higher tax bracket or they are already higher rate taxpayers.
• There is limited protection of the assets from attack by future partners of your children in the case of divorce
• If there is a mortgage lender in place permission will need to be obtained for the transfer. This is unlikely so your children will need to apply for mortgages and it therefore realistically restricts you to property that has no mortgage.
All in all, not a very appetising outlook.
Transfer to a Discretionary Trust
This could be an option for some landlords but you should be aware of the following limitations:-
• You would need to survive for 7 years for the asset to fall entirely out of your estate for IHT purposes.
• If there is a mortgage lender in place permission will need to be obtained for the transfer into the trust. This is unlikely to be granted and it therefore realistically restricts you to property that has no mortgage.
• A maximum of £650,000 (per married couple) can be transferred without incurring an immediate 20% tax charge on any excess. A further £650,000 can then be transferred after 7 years and so forth. For someone wishing to transfer say a £1m portfolio this would require them to survive at least 14 years to eliminate the IHT.
• The capital gains tax on a transfer to a trust can be held over and the asset passed out to your children who also agree to the CGT holdover. This however is merely kicking the can down the road for your children to deal with. If your children wish to sell the property, they would face CGT based on your original purchase price.
• Rental income profits in a trust are taxed at 45%
• There will be IHT exit charges if the property is to be transferred from the Trust to the children in the future
• There will be a 10-year IHT charge on the assets held by the Trust at a maximum rate of 6%, this is repeated every 10 years for the lifetime of the Trust
• The Trust will need to register with HMRC and will need to complete a Trust Tax Return each year
• When transferring a property into the trust you can no longer receive any of the income if you wish to avoid IHT
Discretionary Trusts do have some part to play in Inheritance tax planning particularly if you wish to ensure financial provision for a vulnerable or disabled child after death. so should not be ingnored.
Sale and re-investment
This involves a sale of the properties and then a reinvestment of the gains into a Business Property Relief Investment portfolio. This, does carry some risk as with any stock market investment, but if you were to survive 2 years the investment can be passed on to beneficiaries on death free of IHT. However, Capital Gains Tax is still payable on the sale so a realistic assessment should be made as to the cost/benefit v the risk. Many of the investment vehicles are listed on the AIM or Footsie 350 listing. The risk is the shares may drop in value during your lifetime or the company itself fails and is liquidated in which case you will have lost everything. This can be mitigated by investing through specialist funds which have a spread of companies.
Set up correctly, a limited company can reduce your Inheritance Tax exposure. At the same time you can continue to have full control during your lifetime, full access to dividend income and implement a shareholder agreement to protect your property wealth for your children and your future bloodline. In these circumstances it may be worth you considering a form of planning using “freezer” shares.The intention is to freeze the value of the shares belonging to you so that future growth in value accrues to their intended beneficiary – typically the next generation. This is achieved by altering the company’s Articles of Association to divide the company’s shares into two classes, A and B shares. The A shares carry an entitlement to dividends and/or capital on
winding up equivalent to the current value of the company and are retained by you.
The important thing to note here is that when incorporating the company, your current value is equivalent to the nominal value of your A shares. i.e. £1 per share as there are no other assets in the company. All future growth in the value of the company will accrue to the B shares which will be given to your children or perhaps to a trust that benefits succeeding generations. At this point there should be no IHT implications inherent in this planning. The new B class of shares will have only a nominal value as initially they have no voting rights, no dividend rights and no capital value above their face value.
There has been no significant transfer of value because the value of the existing shares is not substantially reduced. On your death you will be taxed only on the value of the company at the date
the two share classes were created. The same approach can also be used where you have already acquired properties. In this case a valuation would need to be carried out first to ascertain the current value of your shares.
Before deciding whether to buy property in your personal name or through a limited company it pays to know what the inheritance tax outlook is. For property investors who are serious about protecting their wealth, the next step is to get in touch and arrange a consultation with one of our experienced tax advisors.
How Sam & Sarah Saved IHT
Sam, 43, and Sarah, 43, have two minor children aged 8 and 6. They wanted to build a property portfolio to give them extra income in retirement but also to pass on this property wealth to their children.
We were able to set up a Property Family Investment Company (PFIC) for Sam and Sarah who are the Directors of the PFIC and the only shareholders with voting rights, thus maintaining control of the company. At the same time, Sam and Sarah’s shares have restricted rights to any entitlement to the future growth in value and so their shares are effectively frozen in value.
The PFIC acquired properties valued at £1m over three years by using £750k of BTL mortgages and £250k deposits which were loaned to the PFIC by Sam and Sarah. These are treated as Directors Loans to the PFIC and can be repaid to Sam and Sarah free of any tax when the PFIC has enough funds in the future from the rental income.
We created a separate class of shares for the children in which they are given capital rights to the future growth in value of the company allowing the future growth in value of the property assets to accrue to the children instead of being part of Sam and Sarah’s estates for IHT purposes. This has saved Sam and Sarah a significant amount of IHT in comparison to if they had owned the assets in their personal names until they passed these on to the children.
As an example, if Sam and Sarah held these properties personally until the date of death for the last surviving spouse when they were valued at £3m, their IHT liability could be as much as £1.2m (assuming their IHT nil rate bands are already utilised by other assets). Using the PFIC, only the original equity introduced to the PFIC of £250k would be subject to IHT which would be capped at £100k. The PFIC will save Sam and Sarah £1.1m in IHT based on these circumstances. The IHT liability could be reduced even further if Sam and Sarah were to draw down the £250k Directors’ Loan account with the PFIC during their lifetime.
Further, Sam and Sarah are able to take dividends from the PFIC to meet their ongoing income needs and can do so flexibly between each other depending on their marginal rates of tax in any given tax year. If they decide not to take any income from the PFIC, the left-over funds in the company can be rolled up to help pay off the mortgages on the properties or to fund the acquisition of new properties without any additional tax being paid. We helped save Sam and Sarah both a significant amount of IHT and Income Tax and we can help your family save tax too. Please get in touch with us today if you would like more information.
How we can help
We’re one of the UK’s leading specialist accountants for property owners, whether you’re just starting out on your letting journey or you’re a multi-property rental veteran. At UK Landlord Tax we are here to listen to your objectives and to help you achieve your objectives by giving you robust practical advice in plain language with no jargon or long-winded technical explanations.
We can provide the following advice:
. Whether the PFIC is a suitable vehicle for your family based on your personal circumstances
. Tax implications of acquiring properties using a PFIC
. Tax implications of transferring existing properties to the PFIC
. Which family members to include in the PFIC and what rights to provide each family member based on your objectives
. The potential IHT savings available by setting up the PFIC
. How to include grandparents to achieve maximum Income Tax savings as a family
. Setting up a Shareholders’ Agreement to protect the wealth accumulated in the PFIC for the family against any potential claims in the future
. How to extract funds from the PFIC for each family member in the most tax efficient manner
. Other options available to landlords in respect of their existing property portfolio
. IHT advice in respect of your exposure to IHT based on your total assets including those owned in your personal names outside of the PFIC
For a no-obligation consultation please get in touch with us at 01902 711370 or email enquiries@uklandlordtax.co.uk.
Thandi Nicholls Ltd
Creative Industries Centre
Glaisher Drive
Wolverhampton
West Midlands
WV10 9TG
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