Should you gift investment properties into trust for tax planning purposes?
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What with the increasing costs, regulations and taxation being imposed on property investors by the last Conservative government and the current Labour one, it is no surprise that buy-to-let landlords are looking for ways to minimise or defer taxation. Many property investors have resorted to selling their properties. Much higher interest rates have been a factor too of course. It has become increasingly less possible for buy to let investors to be profitable.
The trouble with selling investment properties is the high rate of Capital Gains Tax. Residential property is the only asset class other than Carried Interest which is subject to the higher rate of Capital Gains Tax (CGT) of 24% as opposed to a maximum rate of 20% on any other asset sales subject to CGT. It was only reduced from 28% to 24% in the last Conservatives Budget before they lost the election. The fear now is that Labour will increase CGT in their first Budget on 30 October. Some forecasters say it could increase to 30% whereas others think it may become aligned with Income Tax which means it could reach as high as 45% for additional rate taxpayers. Whatever happens, Labour may well retain a higher rate still for residential property capital gains. This is all a far cry from the early days of Margaret Thatcher’s Conservative government which championed property ownership. It’s interesting how times change.
For those property investors who do not wish to sell their investment properties but do want to leave them to their loved ones, there is the option of gifting the properties into one or more discretionary trusts as an alternative strategy. So how does this work?
You can gift a property into a discretionary trust and defer Capital Gains Tax by claiming holdover relief on that gift until the property is eventually sold within the trust. However, you the settlor, the person making the gift, cannot benefit in any way nor can your spouse, partner, child or step-child. The asset will fall outside of your estate for Inheritance Tax purposes 100% after 7 years and on a reducing scale between completed years 3-7 after the gift where appropriate. The settlor can no longer benefit from any rental income on the properties, as this would be considered a Gift with Reservation (GWR) and unsuccessful for Inheritance Tax planning.
The downside is that within the trust there may be an initial IHT charge, the entry charge, a 10-yearly IHT charge and an eventual exit charge. The rates of IHT are lower than on death but they can still mount up. For example, the 10-yearly charge is at a rate of approximately 6% on the value of the trust less the nil rate band, currently £325,000, available to the trust.
For it to work perfectly it is preferable for the property to have a value of less than £325,000 which is known as the Nil Rate Band. There will be no IHT to pay on a gift into trust below that amount. So if the property is jointly owned with a spouse for example that will mean that the allowance is £650,000.
Whilst this could potentially defer CGT and avoid IHT that doesn’t mean that the property/ies won’t be subject to taxation within the trust/s. The rental income will be subject to Income Tax and a sale of a property within a discretionary trust is subject to CGT and with both taxed at the highest rates.
The tax rules are quite complex. I have only given a brief outline of some of the advantages and disadvantages of such planning. You really need to get professional advice from a legal and tax expert, especially ones who specialises in property and trusts. Nonetheless, it is certainly a strategy at least worth considering if you meet the criteria and this is something you truly wish to do. You know it makes sense.*
*RISK WARNING
The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this blog is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. The Financial Conduct Authority does not regulate tax planning, estate planning, or trusts. This blog is based on my own observations and opinions.
Chartered and Certified Financial Planner
Managing Director of Wealth and Tax Management
If you are looking for expert guidance in Financial Planning contact Wealth and Tax Management on 01908 523740 or email wealth@wealthandtax.co.uk