The economic climate continues to paint a pretty depressing picture for property prices and statistics published by the Nationwide suggest that a property in the Yorkshire region which had a value of £300,000 only two years ago has now dropped in value by about 10 per cent down to £270,000.
Robert Peel, Senior Tax Consultant
While any fall in the value of property is a cause for concern, this does present a unique opportunity for Inheritance Tax planning, in that over the same two-year period the inheritance tax threshold has increased from £312,000 to £325,000.
If you have a second home, this might be an ideal moment to consider getting it out of your estate for inheritance tax purposes and reducing your exposure to tax. This could be a holiday home or an investment property from which you enjoy a rental income.
There are opportunities for making a gift down to the next generation while values are depressed and allowances remain relatively high. You can make a direct gift to your children, but beware of capital gains tax that might arise, particularly bearing in mind that the rate of capital gains tax is likely to increase in the forthcoming emergency Budget.
If capital gains tax is still an issue then consider making gifts through a trust, as capital gains tax can be deferred on a gift into trust. Trusts have for a long time been used to address problems in two main areas: taxation and domestic matters.
Any gift into trust is a chargeable event for inheritance tax purposes and therefore if the property is worth more than the present nil-rate band £325,000 the excess would attract inheritance tax at the present lifetime rate of 20 per cent. This would be in addition to the capital gains tax. A couple making a gift of jointly-owned property would each have their own nil rate band and could therefore jointly gift a property with a value of up to £650,000 free of inheritance tax providing that they have not made any other chargeable gifts within the last seven years.
Do you want to get the property out of your estate for tax purposes but want to be able to carry on enjoying the benefit of the property? This could mean being able to carry on using the property for annual holidays or to carry on receiving the rental income. Thanks to the past efforts of Gordon Brown you can no longer give away assets and carry on enjoying them and thus avoid paying Inheritance Tax on the value of the asset gifted. If you give away an asset but continue to use it or receive the rental income it is not effective for Inheritance Tax purposes and tax will still be payable as if it still forms part of your estate.
Even if you do manage to avoid this trap there is an Income Tax trap waiting as legislation has been brought in which states that if you dispose of an asset and it is effective for Inheritance Tax purposes but you wish to carry on enjoying the asset you will be subject to an income tax charge, similar to a benefit in kind charge, based on 4.75 per cent of the value of the asset gifted away. You can avoid this income tax charge by either accepting that the asset is subject to Inheritance Tax or you can pay a full market rent for the use of the property.
Despite all these changes in legislation, there are, under certain circumstances, still steps that you could consider particularly if you are married with adult children.
If you own a property absolutely, you could consider selling it to your spouse at full market value. You spouse does not have the cash to buy the property outright so the proceeds are left outstanding on loan. As the new owner of the property your spouse is perfectly entitled to occupy the house and can, of course, allow husband or wife to join them on family holidays. You, as the previous owner no longer have the house in your estate but in its place have an outstanding loan from your spouse. The terms of the loan are that it is interest-free and repayable on death. You could then decide that you wish to make a gift of the loan to your children or grandchildren so that in due course the loan is repaid to them and not to you. Providing that you survive for seven years, the value of the loan is outside of your estate and you can still enjoy the use of the property. If it is a rental property your spouse can still benefit from the rents. The Pre-owned Asset Tax income tax charge is avoided.
No capital gains tax is payable on the sale of the property to your spouse as transfers between spouses are exempt for capital gains tax purposes. The only downside is that as it is a sale of the property rather than a gift, Stamp Duty Land Tax will be payable, but even at three per cent on properties valued between £250,000 and £500,000 this is better in the long run than 40 per cent in Inheritance Tax.
This method of reducing exposure to Inheritance Tax does not just apply to second homes but can be applied to other assets such as stocks and shares. It can also work if the property is owned jointly, when one spouse can sell their half share to the other but it does not work for both spouses.
As with most tax planning arrangements it is very important to ensure that the paperwork is completed correctly and getting the documentation right for the loan is crucial. Professional advice is very important to ensure that the arrangement is tax effective.
Robert Peel is a senior tax consultant in the private clients team, he can be contacted by telephone on 0113 2739600 or by email rpeel@garbutt-elliott.co.uk
