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Inheritance Tax is primarily payable on death on the value of your assets at that time. You can reduce the liability by making lifetime gifts and then surviving seven years.
Generally speaking, due to the reservation of benefit rules, it is not possible to make a gift that is effective for Inheritance Tax purposes and retain the use or enjoyment of that asset unless you pay the full commercial rent for the use of the asset. Any rent that is paid needs to be continually reviewed to make sure that it is still the correct amount.
One situation where this will not apply is to gifts of a share in a rental property. In that situation you can still continue to receive all of the rent after the gift. You can retain as little as 1% of the value of the property although HMRC might try and challenge that situation: it is probably better therefore for you to retain at least 5% or 10% of the property in your own name.
Set out below are a couple of scenarios where the rules do not apply.
Scenario 1 – an outright gift
You can give, say, a 90% share of a rental property to an adult child or children. The rent would, in the first instance, be payable to the child/ren who would have to disclose the rent in their own personal Tax Return: an instruction to the tenant however that all of the rent be paid to you would not offend the gift with reservation of benefit (GROB) rules.
An outright gift like this would rely on the goodwill of the child/ren to give the rent back to you. There is also the risk that the child dies before you, becomes bankrupt, has matrimonial difficulties or simply reneges on the agreement.
This outright gift of a share in a property will be “potentially exempt” for Inheritance Tax purposes. If you survive for seven years then the gift falls out of account altogether. In the intervening period however the value of an initial gift will have to be added back as part of your Estate for working out the Inheritance Tax liability on your death.
Scenario 2 – a gift to a trust
An alternative is for you to transfer the share in the rental property into a trust under which you specify that you are to continue to receive the income during your lifetime, after which the share of the property passes on further trusts or perhaps outright to your children. In this situation the rent would still be paid to you in full but the GROB rules would not apply.
The GROB rules will apply if the property is sold and the trust does not re-invest its share of the sale proceeds into another rental property. A pre-owned asset tax liability will arise if not so reinvested.
If the share in the property is transferred into a trust then the gift will be immediately taxable to Inheritance Tax. If the total value of your “chargeable” gifts do not exceed the nil rate threshold applicable at the time then there will be no immediate charge to Inheritance Tax. If it does then there will be an immediate Inheritance Tax charge of one half of the rate applicable on a person’s death. Every individual has a “nil rate allowance” so that, if a married couple or civil partners jointly make the gift they will each have a nil rate allowance which means that a greater value can be passed into the trust before any Inheritance Tax is payable.
The type of trust indicated will be a “relevant property trust” for Inheritance Tax purposes. As a result there will be 10 yearly charges. The calculations for this can be quite complex but, in simple terms, if the value of the trust’s share in the property does not exceed the nil rate band at the 10 year anniversary then there is unlikely to be any tax to pay.
On your death the value of the trust’s share in the property will not have to be included as part of your Estate provided you have survived the requisite seven years. The share of the property that you have retained will form part of your Estate but it should be possible to apply a discount against that value of up to 10% to 15% in respect of jointly held property.
Capital Gains Tax
It is also important to consider the Capital Gains Tax implications. The gift of the share in the property (whether outright or into trust) will be a disposal for Capital Gains Tax even though you are making a gift. The liability will be calculated in the usual way. If the gift is to a trust then, because you will be retaining an interest in the trust property, it is not possible to hold over/defer the Capital Gains Tax liability. It may however be possible to manage the Capital Gains Tax liability by making the transfers over a number of different tax years, taking advantage of your Capital Gains Tax allowance. If the gift is being made by more than one person then each individual can use their own Capital Gains Tax allowance – assuming that they do not make any other gains in the particular tax year.
If the trust continues when you die there will be no Capital Gains Tax charge. If the trust comes to an end at that time (because one or more people become entitled to the assets outright) then there will be a disposal for Capital Gains Tax purposes. In those circumstances any chargeable gain can be held over/deferred so that the beneficiary/ies acquire the share in the property at the Trustees’ original cost. It is not however possible to hold over/defer the gain if the beneficiary is not resident in the United Kingdom at that time. If the beneficiary emigrates within six years of the election then the deferred charge becomes immediately payable.
If the transfer is into a trust and both Inheritance Tax and Capital Gains Tax are payable then there is no facility to offset one tax against the other: both liabilities are payable in full.
Death within 7 years of the gift
Where the share in the property has been transferred into a trust and you die you will not be treated as owning the assets in the trust for Inheritance Tax purposes. However, as mentioned above, if the death is within seven years of the share being paid into the trust then that value will be added back as part of your estate on death for Inheritance Tax purposes.
For more information
If you would like to discuss any aspects of tax or estate planning or would like some further information contact James Hall, Lisa Whitehouse, Donna Holmes or Alex Elphinston who will be happy to discuss matters further.
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