A second home may be a holiday property used by the family for many years, a flat in London used for visits to the capital, or a property elsewhere either used or let out for the income it can generate.
For many property owners there will come a time when they start to think about giving away the property with a view to reducing the ultimate inheritance tax (IHT) bill.
How is that best done and what are the key tax considerations?
Gifting is relatively easy but there are two key tax problems that you need to be aware of. Firstly, it is necessary to avoid it being a reservation of benefit (gift with reservation) for IHT, and secondly, a gift is a disposal for capital gains tax (CGT) purposes.
Reservation of benefit/gift with reservation for IHT
If you make a gift and continue to receive benefit from the property, whether in the form of rental income or use of the property, the gift will be ineffective for IHT and still fall within your Estate.
If you want to retain the income the property can generate, there is little that can be done about that.
The reservation of benefit rules state that for the most part there is a choice between giving away the asset and the income it generates and avoiding IHT, or retaining it but accepting the IHT liability. In some cases there could be a compromise whereby you gift a part of the property and part of the income is retained. This becomes more complicated however by seeking professional advice it becomes a viable solution
Capital Gains Tax
The second main problem to overcome is the fact that Capital Gains Tax is payable on a gift, in a similar way to a sale, and with a second property which has been owned for some years, that tax liability may well be significant.
This is where a trust can be extremely useful. If you make a gift into a trust then, although the gift will constitute a disposal, there is the ability to ‘holdover’ the gain arising to avoid an immediate charge.
The tax has not been avoided but simply deferred, but this avoids the CGT being an obstacle to making the gift which you want to make for IHT reasons.
Gifting a (second) property to a discretionary trust
A trust can be a good way to cut the tax to be paid on your inheritance but professional financial advice is required to get it right.
If you put property into a trust then, provided certain conditions are met, it no longer belongs to you. This means that when you die the value normally will not be counted when your inheritance tax bill is calculated.
Another potential advantage is that a trust is a way of keeping control and asset protection for the beneficiary. The trustees have a legal duty to look after and manage the trust assets for the person who will benefit from the trust in the end.
In a discretionary trust, the trustees have absolute power to decide how the assets in the trust are distributed and the power to make investment decisions on behalf of the trust.
This can be an effective, but not a simple solution, and is important to be aware that it becomes a formal legal arrangement, which will mean the property is no longer yours but instead belong to the trustees. There are additional costs creating and administering the trust plus preparing and submitting tax returns.
Chargeable Lifetime Transfers
Importantly when making a gift into a discretionary trust for IHT purposes, this is deemed to be a chargeable lifetime transfer, and ordinarily you are limited to putting no more than £325,000 per person (£650,000 for a couple) into the trust assets without an immediate tax charge. Anything over and above this level suffers an immediate tax charge of 20%. Additionally, for an inheritance tax saving to be obtained, you need to survive for seven years since the creation of the Trust.
Further tax charges would also potentially arise during the lifetime of the trust, on every tenth anniversary of its creation, depending on the value of the assets within the trust.
Finally, it is also worth noting that if in future you need local authority nursing care, any gift made to a trust can be set aside if the local authority considers it was done deliberately to deprive yourself of assets.
HMRC collected £5.2 billion in Inheritance tax receipts during 2019/20 and will no doubt increase as property values increase over time. This goes hand in hand with the desire of many parents to help their children on the property ladder. Unsurprising finding viable planning solutions for effective reduction of estates through gifts is more sought after than ever before.
This article is for information only and should not be seen as advice or recommendation to act. If you wish to take action then please seek independent financial advice first.
For more information and/or independent financial advice, please contact Rebecca Nkoane, Independent Financial Adviser at Fidelium Financial Planners Ltd.
Fidelium Financial Planners Ltd is authorised and regulated by the Financial Conduct Authority.
The Financial Conduct Authority does not regulate tax and estate planning
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