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As a landlord, if you have children, one of the questions that will undoubtedly cross your mind is how you can leave your property wealth to next generation in a tax efficient way.
One of the advantages of owning property in a limited company is that it can offer a way for you to pass on your property wealth and mitigate Inheritance Tax. This could be achieved by including your children in the company’s ownership structure by setting it up as a Family Investment Company (FIC).
A FIC is a private company owned by family members, which can be used as a long-term investment strategy for passing assets on to your children and potentially mitigating future Inheritance Tax. This is achieved by setting up a limited company with a tailored share structure that assigns different shareholder classes and rights, so that you can protect your assets for the next generation.
Benefits of a limited company
All limited companies, whether or not they include children, have benefits that make them a more attractive option for owning rental properties for many landlords compared with ownership in personal names. We take a look at some of the main benefits:
Tax rates
Adam (age 47) and Emma (age 46) are married and have four children:
Sam (age 19), Callum (age 14) and twin daughters, Mary, and Ashley (age 7).
Adam and Emma are employed and are both higher rate taxpayers.
If Adam and Emma decided to use a limited company to hold their rental properties, any rental profits will be taxed at Corporation Tax Rates which are:
- Profits up to £50,000, the Corporation Tax rate is 19%.
- Profits between £50,000 and £250,000 the Corporation Tax main rate of 25% will apply but Marginal Relief will be given. Marginal Relief provides a gradual increase in the Corporation Tax rate between the small profits rate (19%) and the main rate of 25%.
- Profits exceeding £250,000, the Corporation Tax rate is 25% and this is known as the main rate.
- Profits up to £50,000, the Corporation Tax rate is 19%.
- Profits between £50,000 and £250,000 the Corporation Tax main rate of 25% will apply but Marginal Relief will be given. Marginal Relief provides a gradual increase in the Corporation Tax rate between the small profits rate (19%) and the main rate of 25%.
- Profits exceeding £250,000, the Corporation Tax rate is 25% and this is known as the main rate.
Inheritance tax
Inheritance Tax (IHT) is a tax on the estate of someone who has died or on lifetime transfers of value. Normally there is no IHT to pay if the value of the estate is below the Nil rate band of £325,000. There is an additional £175,000 residential nil rate band if there is a main residence in the estate.
The Inheritance Tax rate on death is 40% and 20% on lifetime transfers that exceed the available nil rate band thresholds.
Purchasing properties through a limited company, allows for Inheritance Tax planning to reduce the value of the estate by passing some of the capital value along to children.
For Adam and Emma, let’s assume their main residence is worth £1 million utilising their combined nil-rate bands in full.
Their limited company over a three-year period acquired townhouses in Manchester valued at £400,000. They took out a £300,000 mortgage and contributed a £100,000 deposit to finance the purchases.
Over the next 35 years (based upon their life expectancy), the properties could increase in value to say £1 million and be mortgage free.
Assuming all assets pass on the death of the first spouse to the surviving spouse, they will have an estate for IHT purposes in the region of £2 million. On this basis the nil rate bands available total £1 million. Therefore, the potential IHT liability on the remaining £1 million would be £400,000.
Potential company structure
In Adam and Emma’s case, a Family Investment Company set-up could help them avoid this £400,000 IHT charge. This would involve each shareholder owning a separate class of shares with different rights assigned to each class of share.
- Voting Rights – Full rights to receive notice of, attend and vote at general meetings.
- Dividend Rights – Rights to receive dividends.
- Capital Rights – Rights to capital distributions (including upon winding up).
A typical structure would look like this:
| Name of Shareholder | Class of Share |
|---|---|
| Adam | Ordinary A |
| Emma | Ordinary B |
| Sam | Ordinary C |
| Callum | Ordinary D |
| Mary | Ordinary E |
| Ashley | Ordinary F |
| Number of Shares | Voting Rights |
|---|---|
| 480 | Yes |
| 480 | Yes |
| 10 | No |
| 10 | No |
| 10 | No |
| 10 | No |
| Dividend Rights | Capital Rights |
|---|---|
| Yes | No |
| Yes | No |
| Yes | Yes |
| No | Yes |
| No | Yes |
| No | Yes |
In this structure, Adam and Emma, the directors, hold the majority of the company's shares which gives them control over the decision-making process and they also have voting rights and dividend rights. However, their shares have no capital rights, meaning the share value is frozen at incorporation which mitigates their exposure to Inheritance Tax.
Since Sam is nineteen years old, he is of legal age to pay Income Tax and can receive dividends. As a result, he has been granted dividend and capital rights from the company.
In contrast, Callum, Mary, and Ashley, who are all under 18, would not receive dividends rights and would only been assigned capital rights. This results in the four children being granted all future growth in value of the company assets to their shares.
On the death of the second spouse, we assume that the voting A and B shares would be left to the children and they would then effectively control the company and avoided any Inheritance Tax.
It can be seen for IHT purposes, the revised position using a Family Investment Company would be as follows:
Individuals are required to pay Capital Gains Tax (CGT) on any gains made on the sale of a property. CGT rates for residential properties are 18% for basic rate taxpayers and 24% for higher rate taxpayers.
For individuals and limited companies, if their turnover exceeds £90,000 over a 12-month period from a property that meets certain furnished holiday lettings criteria, you must register for VAT. This will mean that you will be required to charge VAT on your income and submit VAT returns.
Conclusion
Compared with a standard limited company, a Family Investment Company structure could enable you to go forward with your property investments, allow involvement of children, retain your access to income, enable full control during your lifetime and incorporate passing growth in value to your children and out of your estate for IHT purposes.
For higher rate taxpayers it therefore offers substantial benefits for long term property investment.
