A Capital Tax planning starter pack for property owners of all shapes and sizes

There is currently considerable speculation in the UK about changes to the UK tax regime which the new Chancellor will announce in the forthcoming Budget on 30 October.  These may include changes to announcements that were made earlier this year by the previous government.  It is possible that the October announcements will affect what follows in this note.

All property acquired by a private owner forms part of their estate (i.e. their assets) for tax purposes and UK real estate, in particular, will fall within the scope of UK inheritance tax (IHT) to be taxed potentially at 40% on its market value on the owner’s death.

With UK property often making up the majority of an estate by value, planning to mitigate its impact is a hot-topic, but not always properly understood.

The aim of this note is to cover the property-owning scenarios we see most regularly in practice and to pick up the most common issues our clients encounter. There should be something for any individual reader who owns property in some shape or form.

The topics we will cover are:

1. Homeowners – the family home
2. Second homes, holiday homes or let properties
3. The portfolio of properties
4. Property investment companies
5. Landowning businesses
6. Development land
7. Foreign real estate

1. Homeowners – the family home

The scenario

For the majority of us, the family home is our biggest asset and makes up the majority of our estates. Mitigating IHT on it can therefore reap significant rewards financially for the heirs and saving that tax is a natural motivation.

The issues
 

A misunderstanding we see all the time is that simply signing over the house into the children’s names is effective planning for IHT, because the children are then the owners. This is hardly ever ‘job done’ and in most cases it achieves nothing other than a muddle about who owns what in reality.

Gifts are effective IHT planning where the owner (the donor) gives assets away and survives the gift by seven years. The gifts are known as ‘potentially exempt transfers’ (PETs) because they are chargeable to IHT if the donor dies within the seven-year period (i.e. potentially) and become exempt after seven years.

The reality is that effective planning for the family home using gifts / PETs is hardly ever straightforward. This is because the owner will invariably continue living in the property and there is long-established and widely applicable anti-avoidance legislation, notably the ‘gift with reservation of benefit’ (GROB) rules, which is designed to defeat IHT planning when there is a gift but the donor continues to occupy or enjoy the use of the asset given away. A gift which falls foul of the GROB rules is treated for IHT purposes effectively as if it had not been made so will still be charged to IHT on the donor’s death.

The options
 

Gift within the limited GROB exceptions and survive seven years

 

The gift could be to individual(s) or a trust, but a gift to trust will suffer an upfront 20% IHT charge for values above £325,000 per donor (£650,000 if both spouses settle the trust).

The GROB exceptions are:

Very minimal ongoing use – a maximum of 2 weeks each year or one month each year with the donee. For the family home this will not apply.

Pay a market rent for the ongoing use – effectively a full annual market rent. For most this will be unaffordable or unacceptable.

Give an undivided share of the property to an individual and co-occupy with them – this requires very specific circumstances.

If none of these exceptions can apply, this tends to be the end of the discussion on a gift of the family home.

It should always be remembered that a gift of a property is also a disposal for capital gains tax (CGT) so it can cause a CGT charge to apply if the property has increased in value during ownership (currently at 24% on the gain).

There are some advantages for planning with the family home however. Family homes will usually qualify for the main / private residence exemption so a gift is free of CGT.

That means that, in rare cases where one of the GROB exceptions applies, the gifting can be free of IHT and CGT when made, but subject to the seven-year rule for IHT.  This can be very effective planning.

Ensuring the IHT residence nil rate band applies in full to maximise the tax-free amount that can be given away on death. Having this available is worth £175,000 per person, or £350,000 per married couple, equivalent to £140,000 IHT saving. Broadly it requires a gift of a residence to a direct descendant and it applies on death.

Reduce the value of the property chargeable to IHT, for example:

Sensible borrowing secured on the property will reduce the value chargeable to IHT, but usually subject to interest charges, e.g. a mortgage or equity release.

Joint ownership with others may result in a valuation discount, so the valuation of a 50% share may be less than the full value of 50%. 

Sell shares of the family home to other family members for market value and spend / give away the proceeds so they aren’t in the estate.

Planning tips

 

Take expert advice and do not trust the internet or your neighbour on what to do!

Acting without advice can actually put you in a worse tax position then when you started. So doing nothing may be the better option, albeit reluctantly.

Make a suitable Will to ensure the residence nil rate band will apply where it can.

 

2. Your second home / holiday home / let property

The situation

On the face of it, we are dealing with a situation similar to the family home, but the owners will use and benefit from the property differently, i.e. no or reduced use and enjoyment, and perhaps just the receipt of rents.

The issues 
 

These will depend on the use and enjoyment of the property, both now and in the future.

Where there is going to be ongoing use or receipt of rent, the issues are similar to the family home. The GROB rules and CGT must be considered.

For some properties the donor will not use the property, e.g. an investment property that is let. That makes the IHT planning easier because it isn’t necessary to consider the GROB rules in the same way as they are not in point. The residence nil rate band will usually not apply to these properties and CGT must also be considered.

The options

Gift within the limited GROB exceptions and survive seven years

If the GROB rules apply, the exceptions may be more palatable in practice, e.g.:

Minimal ongoing use – two weeks or one month with the donee may be enough.

Paying a market rent – the rent required is reduced to the amount the property is used after the gift, so if the donor gives away, say, 50% of the property, but then uses it for only three months each year, they will need to pay 3/12ths of 50% of the market rent for the whole property, equivalent to 12.5% of the annual market rent. This may be an acceptable trade-off to ensure that 50% of the property’s value leaves their estate.

Give an undivided share and co-occupy with the recipient –occupation is not defined, but it might arguably cover the use of a holiday home at different times of year by the different co-owners with some overlap; it would need proper consideration.

However, bear in mind that PPR does not apply for CGT so a gift of a property that has increased in value will crystallise a CGT charge. Without a corresponding sale of the property realising cash, that will be a dry tax charge which in many cases will be prohibitive. Therefore, the difficulty when planning for these properties may be CGT rather than the IHT rules.

The other options above apply for the family home, but the residence nil rate band is unlikely to apply to a property which has never been a residence. This is not always obvious. 

Planning tips

 

Ideally, identify a property that the donor will never need to use again or benefit from and consider making a gift of it in lifetime.

Look for a property standing at a minimal gain or where capital improvements spent on the property reduce the gain to a manageable level.

Check if the donor has unused capital losses which can be used to offset a gain.

If none of those apply, consider a gift into trust of value up to the IHT nil rate band threshold (currently £325,000) and claim holdover relief for CGT purposes. Then there would be no upfront IHT or CGT charge on the planning.

 

3. The portfolio of properties

The situation

The owner owns a number of different properties in direct ownership, sometimes a large overall number split between the different types discussed above.

The issues

 

Since each property is directly owned, each one needs to be considered separately. This can be a big task for a large number of properties.

The options

 

The appropriate options and situations discussed above should be considered for each property.

Planning tips

On top of the tips above, non-tax factors should be given weight where there are a number of properties on which potentially to plan.

Where there is a choice of properties to give away in lifetime for example, a cost / benefit analysis is important, including the loss of income to the donor, but also perhaps a reduction in their liability for maintenance costs in the future, which can be considerable for properties.

 

4. Property investment companies

The situation

In this scenario, the properties will not be owned directly, but will be owned through a company.

The issues

 

The owner’s asset will not be the properties themselves, but the shares of the company which owns the properties. Planning then centres around the shares as opposed to the properties.

Unless individual properties qualify for IHT relief in their own right, which should always be checked (e.g. agricultural land qualifying for agricultural property relief), the valuable business property relief (BPR) cannot apply because by its nature a property investment company is not trading for IHT purposes.

The options

Issuing growth shares to restrict the future value growth of the owner’s shares in their estate, and to enable that growth to accrue in their chosen successor’s estate.

Fragmentation of ownership to result in minority share classes and achieve valuation discounts, i.e. reducing the value on which IHT is charged.

Debt to reduce the value chargeable to IHT.

Capital gains tax will need to be considered as a gift of shares will be chargeable to IHT. Holdover relief may assist on a transfer to a trust.

Planning tips:

This is another area where specialist advice is essential, because it is simply not possible to consider IHT and CGT in isolation. All taxes need to be considered by a specialist in order for the planning to meet all the aims set. However, effective planning can be and is frequently achievable.

Consider the wider family picture and the beneficiaries’ wishes because the tax cost of extracting value from the company in the longer term can be significant.

 

5. Landowning businesses

The situation

Landownership covering larger areas of land as well as properties. A business or a combination of businesses will be undertaken on the land. Farming is an obvious land-centred business, but there is huge diversity in the types of businesses seen that operate on land or from properties situated on the land.

The issues

 

With high land values, the capital value of the overall assets can be very significant so a prospective IHT charge on the death of the owner at 40% can be detrimental.

As with any family business, it is often the family livelihood which has survived and passed down generations. Significant IHT charges can cause the land and business to have to be sold.

The options

 

The business nature means that IHT business property relief (BPR) may be available to the owner offering 100% relief, i.e. complete relief from IHT. Above all this gives the owner options:

Tax-free gifting during lifetime to individual(s) (subject to CGT) or to a trust.

The ability to retain assets until death and effect a Will plan, allowing them to enjoy the benefit of the assets for the rest of their lives.

Large land holdings might comprise a combination of business and investment (non-business) assets. Residential properties are usually investment assets in nature as are any properties that are let, whether residential and commercial properties or let land. Potentially IHT relief can be achieved on the whole estate if it is comprised in a single business, e.g. through a partnership, and less than 50% of the assets are deemed to be investment. BPR can then apply to it all.

Planning tips

 

Start early – IHT reliefs have a minimum holding period to apply, which is usually at least two years, but can be up to seven. 

Active planning can reap dividends over a longer period, for example where business planning decisions are made to reduce investment and to increase trading. Where the business does not qualify for BPR, active management may result in the whole business qualifying in future, which can be very valuable. 

Keep the position under review at least annually, especially for reliefs that are dependent on changeable metrics, e.g. BPR.

 

6. Development land

 

The situation

 

A piece of land has planning potential, e.g. by being listed in a local plan, or because it is suitable for development. There is a real prospect of planning permission being granted.

The issues

Coming into a windfall when planning permission is granted and land is sold for development is obviously good news for anyone. However, the owner could then have a very valuable asset sitting in their estate, which is exposed to IHT on their death.

The options

Receive the proceeds and give away cash subject to the seven-year survival requirement for a PET. This leaves exposure for the seven-year period and is not ideal for that reason.

Give away the land or a share of it to an individual prior to planning permission while the value is lower. This has the same seven-year IHT tail and will be a disposal for CGT potentially triggering a CGT charge.

Consider a transfer of the land to a trust prior to planning permission while the value is lower. There would be no charge to IHT if the value transferred is within the IHT nil rate band (£325,000) – hence it is best to plan with lower values so more can go in - and gains can be heldover for CGT purposes.  

Planning tips:

 

Start early – land with mere ‘hope’ value will be worth a lot less than with planning permission.

Identify any portion of the sale proceeds that are surplus to your requirements and consider planning over just that part. Always preserve enough for your needs first.

Then when planning permission is granted, the value growth is entirely outside the former owner’s estate and will not be subject to IHT on their death, and can benefit successors in the trust.

 

7. The Foreign Element

The situation

1. Foreign owners of UK property
2. UK owners of property abroad

The issues

 

UK property is subject to IHT however and by whomever it is owned, i.e. whether owned directly, in trust or through a company in the UK or abroad. The foreign owners are therefore exposed to IHT on that asset.

Property owned abroad is subject to UK IHT if the owner is UK domiciled or deemed domiciled, because they are then subject to IHT on their worldwide assets. It is never the case of foreign property being out of sight and out of the scope of IHT!

The options

 

The same planning considerations for UK owners will usually apply. For foreign properties, the options may be determined by the local rules.

Planning tips:

 

In our opinion, obtaining foreign law advice is essential in almost all cases.

There are also anti-avoidance measures (relevant loans rules) targeted at foreign buyers / owners of UK property meaning that specialist UK advice should also be taken.

 

Further information

This note is intended to be a general overview only of some of the UK tax aspects of owning property. It is not intended to be a comprehensive review. For example, it does not cover issues for foreign owners, the concepts of domicile or residence, and the potential changes to be implemented by the new Government in its upcoming budget which are widely expected to affect the scope of inheritance tax.  It also does not cover trust ownership of properties. Nor does it cover any other taxes which are relevant to the ownership and enjoyment of UK property, e.g. stamp duty land tax and income tax.

There may also be implications in other jurisdictions depending on where the property is situated and the owner’s tax position. 

Early advice should always be taken when considering the purchase or sale of a property, and planning in connection with it.  A regular review of the tax implications of an owner’s overall estate would inevitably be prudent.

Please get in touch with Charles Richardson at crichardson@kingsleynapley.co.uk if you would like to discuss the UK IHT or CGT implications of owning property, or your estate planning generally, or Matt Spencer at mspencer@kingsleynapley.co.uk if you would like to discuss anything else tax-related.