Home is where the heart is. For most people a home is their most valuable asset. As estate planning becomes increasingly common, people are looking for ways to pass on their property to their loved ones while avoiding potential tax pitfalls.
Taking steps to mitigate your inheritance tax (IHT) bill as well as avoiding Capital Gains Tax (CGT) is fundamental to getting the most out of your property.
Why should you use a trust?
Revenue & Customs considers the market value of the property received, even if the property was given away for free. Capital Gains Tax will be based on that value, minus the purchase price and capitalised refurbishment costs. The rate of CGT to be paid on buy to let (BTL) properties is 18% for basic rate taxpayers and 28% for high rate taxpayers (after they’ve used their £12,000 CGT annual allowance).
Ordinarily, there will be a CGT liability if you wish to transfer a BTL property to your children. However, if you want to transfer properties from your estate to your children but do not wish to pay CGT and would like to avoid IHT, transferring it to a trust is the solution.
You should consider transferring BTL properties into a trust and back to your offspring to reduce your income tax (particularly if you are a higher rate taxpayer), to provide an income for your offspring, and to reduce IHT.
Using a trust to transfer BTL property
You can avoid CGT and IHT on BTL properties by transferring them into a trust. This action leverages Section 260 of the Taxation of Chargeable Gains Act.
The first step to implementing this strategy is to find a property that has a value of less than the IHT threshold of £325,000. Anything above this value will be subject to IHT at 20%. Next, once you’ve paid off the mortgage, transfer the property into a trust and calculate the IHT liability.
After a period of time transfer the property from the trust to the adult child and calculate the IHT exit charge.
Within a year of that transfer, complete and submit the IHT100 form.
Leaving an asset in trust may trigger a ten-year tax charge. You will want to tax further tax planning guidance to avoid this.
Once you decide to transfer the asset from the trust to your child, you must also consider exit charges. These are another form of tax over and above the 20% paid.
It is also important to note that this will not work if you are transferring assets to a minor. Any assets passed from a parent to a minor remain an asset of their estate. Any income derived from the asset is treated as income for the parent for income tax purposes.
Furthermore, it is unlikely that the mortgage company will support your use of a tax avoidance strategy. As such, you will need to ensure that all mortgages for the property are paid off and the property remains unencumbered upon the transfer.
It is entirely possible to transfer a property and avoid paying CGT and IHT. To prevent a slip up, you must plan well in advance. It can get complicated, so if in doubt – work with a specialist!