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Top 5 inheritance tax planning tips for property investors

Top 5 inheritance tax planning tips for property investors

Inheritance Tax (IHT) on property is something investors must consider as part of their long-term financial planning. This is especially a case for the large percentage of investors who get into property not just to create a steady income stream for themselves, but to hand on capital to their children in time.

However, if your wealth is tied up in residential lettings property then it is likely that IHT will have to be paid on the value of your estate once you have passed.

What is Inheritance Tax in the UK?

Inheritance Tax is a tax paid on the estate of someone who has passed away. The includes on the value of any property passed on. The only circumstances where it does not apply are:

  • The value of your estate is below £325,000, OR
  • Everything over £325,000 is left to your spouse, civil partner, a charity or a community amateur sports club

If neither of those criteria apply, your estate will be taxed at 40% on anything above the Inheritance Tax property allowance threshold of £325,000 when you die. This threshold becomes 36% if you leave at least 10% of the value to a charity after any other deductions in your will.

However, Inheritance Tax can be tricky and comes with other exceptions in specific circumstances. For example, the Residence Nil-Rate Band potentially allows you to pass on an additional £175,000 tax-free to your direct descendants on top of the £325,000 allowance, meaning you could pass a property worth £500,000 tax free to your children or grandchildren.

In this area of tax specifically, so much depends on your individual circumstances that we highly recommend you talk to an independent financial advisor to determine your responsibilities.

Property investment and Inheritance Tax can be a tricky subject, so we have put together some information about ways to reduce your liability and pass more of your capital on. Read on to find out more about how to avoid Inheritance Tax on property where you are legally able to do so…

Give your properties away

The simplest way to avoid the need for IHT to be paid on your estate is to give it to your children in advance of your passing. Any property that you sign over to your children or other named beneficiary more than seven years before your death will be exempt.

The obvious downside is that you must give them away a long time before you may otherwise want to. When you do so, you must divest yourself entirely from the properties, and that means giving up the rental income as well. So, if you take this path, make sure that your remaining income stream is secure and enough to meet your needs in the future.

The other consideration when it comes to gifting property to beneficiaries is that they will be liable for Capital Gains Tax if the value of the property has increased in the time you have owned it. Likewise, if there is still a mortgage on the property which is also passed to your beneficiary, HMRC will class this as payment for the property which may trigger Stamp Duty.

Please make sure to speak to an independent tax advisor if you choose this option in order to ensure that you are working with information specific to your situation.

Set up a trust fund

Setting up a trust fund is one potential way to manage your IHT liability. This is where you make a legal arrangement for money, property or other investments to be looked after for the benefit of a third party trustee. After you set the trust up, you will not be able to access it anymore – so if you were to place a property into a trust you should be very certain that this is the right option before doing so.

However, the act of placing an asset into a trust and transferring ownership from yourself to another means that it will no longer be considered part of your estate. Therefore, after seven years it would not be liable for IHT unless it is an exempt transfer.

Trusts are not exempt from taxation, despite popular perception, but the level of taxation is much less than a potential inheritance tax charge on a property over the IHT value limit described previously. As always, we would strongly advise that you talk to an independent financial advisor before setting up a trust fund for your property.

Use a limited company

It might be possible to use a family investment company structure to mitigate IHT liability depending on your situation. According to UK Landlord Tax, you can do so while also retaining control over the company by using a form of planning called ‘freezer shares’.

This involves altering the company’s Articles of Association and splitting the company’s shares into different classes, A and B. The two types of shares will have different entitlements and potential dividends. At the point of splitting, you can choose to freeze the current value of the ‘A’ shares (belonging to you) and accrue all future value in the ‘B’ shares (belonging to your beneficiary).

In this way, you can retain control of the total financial value of the portfolio as it grows, and still decide on dividend distribution, but without creating a significant transfer of value which could attract higher IHT costs.

Please bear in mind that the rules around limited company incorporations are open to change at any time, and this advice should not be taken as binding or evergreen. As always, please make sure you talk to an independent financial advisor before making any decisions.

Use life insurance

It is possible to take out a life insurance policy which will cover your IHT liability. To do this, you would need to work out the value of your portfolio – or the value you imagine it growing to – and take out a policy which will cover the IHT cost association with that.

For example, if your estate is set to be worth £525,000, you would need to deduct the tax free portion (£325,000) and then work out 40% of what is left (£80,000) before arranging a policy in that amount. Importantly, you must make sure that the policy is written in trust so that it goes directly to your beneficiaries upon your death.

If you do not do so, the policy payout will form part of your estate and will itself accrue further inheritance tax which will be payable by your beneficiaries. The younger you are when you take this policy out, the less costly it will be – although of course it will be harder to know the size of your portfolio at a younger age.

Talk to an independent financial advisor

We have stressed throughout this article the need to involve an independent financial and/or tax advisor at each stage of the process. This is the most important piece of advice that you should take from reading this and we cannot emphasise it enough.

The laws around tax, legalities, limited companies and more are changing constantly and it is extremely difficult to stay on top of them. It is best left to professionals whose job it is to know the ins and outs, and who also can recommend the best way forward without emotional attachments colouring any judgements. Personal financial affairs are often clouded by emotion, and none more so than the issue of inheritance tax.

Property investment is one of the best ways to build capital and provide a safe, secure future for your family in the short- and long-terms. Employing an independent advisor is the best way to make sure that you can maximise your portfolio in a safe and legal way.

Want to learn more about investing in property and building capital for your children? Get in touch with our team of experts today and start your investment journey by clicking here >>

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Mallam Grant
Ginny Wai 2
Conor Armstrong
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