AS THE PANDEMIC becomes more of a way of life rather than something that can be avoided, many are looking to straighten their tax affairs with regards to passing wealth to the next generation and mitigate Inheritance Tax (“IHT”). Current social media trends are questioning whether it is even right to leave a legacy to heirs.
Away from these discussions, in today’s Shipleys Tax brief we look at whether it is possible to reduce or avoid inheritance tax by gifting property to your children, but it can be quite complicated, and it is easy to get it wrong. Professional advice should be taken in advance, but as a quick explainer see today’s blog below
What is IHT?
A brief explainer here. If you plan to pass on assets or money after you die, your heirs could face a tax bill of up to 40% of your estate. Your estate is defined as your property, savings and other assets after any debts and funeral expenses have been deducted. You can reduce or avoid IHT in a number of ways (IHT is often called the “voluntary tax”) There’s a tax-free allowance, and you can also give away a certain amount of your money during your lifetime, tax-free and without it counting towards your estate.
If you plan to pass on assets or money after you die, your heirs could face a tax bill of up to 40% of your estate.
So whats the plan?
No one likes the idea of the taxman taking a chunk of their estate when they die, particularly if it will be necessary to sell a much-loved property to pay the inheritance (IHT) bill.
The introduction of the residence nil rate band (“RNRB” – currently set at £175,000) means that a couple can now leave combined estates worth £1 million free of inheritance tax where this includes a residence valued at £350,000 or more, which is left to direct descendants. However, the RNRB is reduced where a person’s estate is worth more than £2 million and lost where the value of the estate exceeds £2.35 million.
If it looks likely that there may be IHT to pay, the idea of taking steps to reduce this is attractive. Where property is given away more than seven years before the donor’s death, it escapes IHT. Giving property to the children may, at first sight, be an attractive option, but are there are traps to be aware of?
The introduction of the residence nil rate band means that a couple can now leave combined estates worth £1 million free of inheritance tax..
Giving away the main residence
If the main residence is given away, there will be no capital gains tax to pay as long as the main residence exemption applies in full. However, if the property is retained by the children as an investment property, the capital gains tax clock will start to run from the date that they acquire it. By contrast, if the property is gifted at death, there will be a capital gains tax uplift to the value at death, but there may be some inheritance tax to pay (potentially at 40%).
Tax problems arise if the parents give the property to the children but continue to live in it. There are two sets of rules that can affect this adversely – the gifts with reservation rules (GWR) and the pre-owned asset (POA) rules.
The GWR rules apply where a donor gives an asset away but continues to derive benefit from it. An example would be parents who transferred their home to their children but continued to live in it. In this case the rules effectively ignore the transfer for inheritance tax purposes, such that it forms part of the death estate.
The POA rules impose an income tax charge on the previous owner if they give a property away but continue to live in it, based on a notional market rent of the property.
If the main residence is given away, there will be no capital gains tax to pay as long as the main residence exemption applies. However, if the property is retained by the children as an investment property, the capital gains tax clock will start to run from the date that they acquire it.
Investment property
Seeking to take an investment property outside of the death estate can trigger a capital gains tax charge where a property is given to a child, even if no money changes hands. The child is a connected person and the property is deemed to be disposed at market value. This may trigger a capital gains tax bill of 18% or 28% of the gain (to the extent it exceeds the annual exemption), which must be paid within 30 days (but with no proceeds from which to pay the tax).
The best advice?
Giving away property in an attempt to save inheritance tax can be very complicated and it is easy to get it wrong; professional advice should be taken in advance to avoid the many pitfalls that lay in tax legislation.
Shipleys Tax have a wealth of experience providing practical and affordable IHT mitigation strategies.
If you are affected by any of the issues above and would like more information, please call 0114 272 4984 or email info@shipleystax.com to arrange a free no obligation consultation.
