On Landlords, Capital Gains Tax, Inheritance Tax and How to Plan to Reduce Both

This short article is about the interaction of Inheritance Tax (IHT) and Capital Gains Tax (CGT) and how, via tax planning, people can reduce the impact of both. It explains that the key thing is to do this when you are still young or else you and /or your heirs may end up paying even more tax that you need to.

On Landlords, Capital Gains Tax, Inheritance Tax and How to Plan to Reduce Both

The main way to cut inheritance tax liability is to reduce the size of your estate that is being passed on. The first £325,000 of any estate is exempt and the so called “nil rate band” can be doubled by passing on the assets to a spouse before death.

Giving property outright to a dependent who is over 18 will be counted as a potentially exempt transfer or PET, which means there is no liability for inheritance tax at the time the gift was made. But this allows for no flexibility or control and of course, will not be suitable for children.

So instead, it may be better to make gifts to a discretionary trust, which will be counted as a chargeable lifetime transfer rather than one that is potentially exempt.

But there are certain issues to consider.

First, if there is a capital gain on the property, the outright gift will give rise to a capital gains tax charge which is set at 18% or 28% depending on whether the person is a basic or higher rate taxpayer.

You can mitigate capital gains tax if the amount of chargeable gain is under £6,000 in a given year, though this is soon to be reduced to a pittance of £3,000 from 2024/5. Hardly worth worrying about!

Paying a relatively low capital gains tax rate of 28% on the capital gain slice of a property’s value rather than the IHT rate of 40% must make sense to anyone!

Putting the property into a trust means any payment of capital gains tax can be deferred until the asset is sold or otherwise disposed of by the trustees.

But such planning could run into problems if the landlord dies earlier than in seven years’ time, as under this rule, any gift made during this timespan before death gets put back into the donor’s estate for inheritance tax purposes, meaning it will be once again, subject to the 40% rate, if the donor dies inside 3 years. It is not until seven years that the full taper is realised and it sits fully outside the estate.

So, if you die within 7 years and have not achieved “the inheritance tax saving” then you will have incurred a greater tax liability as a result of making the gift than you would have incurred if you had simply just left the property in the estate.

And in such a situation, the only tax saved will be the capital gains tax on any growth in the value of the asset after it had been given away, which will certainly be outweighed by the inheritance tax payable on the total.

Of course, if you give anything away, you are also giving the income stream from that asset away too. You cannot enjoy eating the saving on the tax cake as well as still getting the income from the asset!

So, one option would be to gift a share of a buy to let property. Up to 50% share in a property may be gifted to a trust under which the property owner has an “interest in possession”, which means they can still enjoy an income from it. The share being surrendered is called a “gift with reservation”. A landlord doing this will continue to get the rental income generated by the gifted share even though it will no longer be part of their estate for inheritance tax purposes.

Of course, some landlords have put their properties into company structures, which can lend itself to inheritance tax planning because shares in a property company are easier to dispose of incrementally over time.

Also, it can be useful as the shares in a company cannot be wound up without the agreement of the rest of the shareholders, including obviously, the original property investor.

But putting properties into a company is complicated and is not suitable for everyone, because there will be stamp duty land tax and capital gains tax implications to think about, though the company could reduce the stamp duty land tax bill by seeking multiple dwellings relief – this is available if you have a portfolio of at least six properties.

It’s possible to get incorporation relief, which is a way of deferring CGT when assets are transferred into a company. To get incorporation relief the landlord would need to show they are putting at least 20 hours of their time per week into running the company. In the company structure the company can offset all interest relief, whereas you can only offset 20 per cent as a tax credit if the property is held in your individual name.

Plan Early

It is much better to set up a company at a younger age when building up a property portfolio. Younger landlords who fall into the 40 0r 45 percent income tax bracket will be able to reinvest those savings made by paying the lower corporation tax rate when accumulating their property portfolio. The additional growth they benefitted from while that portfolio was growing inside the corporate tax wrapper will usually outweigh the extra tax they will have to pay when they start extracting that profit as dividends in retirement. (Of course the government can reset tax rates at any time).

But for now, the company structure is really one you should be doing when starting off. In this way it can be a great long term strategy.

A Family Investment Company structure can be good because once you have paid the corporation tax, you have control over the distribution through different share classes and dividends. Trusts are also worth looking at because the CGT element can be deferred too.

it is always best to keep things under constant review and take early and ongoing advice – and have a long term plan. Review your portfolio regularly in terms of thinking of where you want your wealth to go – and so you also know how big your liability is for inheritance tax too.

Maybe the best bit of advice is to plan your strategy early, not leave it until you are in your mid 60s.

In June 2020, I wrote this blog piece about some of the considerations people should think about before making the decision to move their portfolio into a company structure:

landlords moves to company structures may be seen as a tax avoidance Ruse. – Letting Focus

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