In partnership with
With significant growth in property values, a major concern for landlords is how to avoid Inheritance Tax on BTL property. To understand the background as to why this has now become a pressing concern for many landlords is that historically up until 2017, most landlords purchased rental property in their personal names. For many, when considering an investment into BTL property, landlords did so hoping to achieve the following:
- Long term capital growth
- Supplement their current and retirement incomes
- To protecting their property wealth and pass on the assets to their children
- Avoid high rates of personal tax on the income.
The do nothing approach or I will not be here so it does not affect me..!
On death, the net equity in your investment properties will be included as an asset in your estate for IHT purposes.
You do get a £325,000 nil rate band doubles to £650,000 if you are married. The nil rate band can go up to £500,000 if you are leaving your Cash to your children and grandchildren. This can go up to £1m for married couples.
It does not take much these days for you to have your own home worth more than £650,000. The following IHT calculation demonstrates this position more clearly. A married couple have a Cash worth £750,000 with no outstanding mortgage. They also have a number of BTL rental properties worth £2m on which there are outstanding loans of £1m.
Estimated inheritance tax 
Assets
| Main residence | £750,000.00 |
| Investment property | £2,000,000.00 |
| Cash | £- |
| Other investments | £- |
| Gross assets | £2,750,000.00 |
Less: Liabilities
| Mortgage for Main Residence | £- |
| Mortgage for Investment | £1,000,000.00 |
| Other debts | £- |
| Total liabilities | £1,000,000.00 |
Net value of estate |
£1,750,000.00 |
| Available Nil Rate Bond | -£325,000 |
| Available Nil Rate Bond of spouse | -£325,000 |
| Available Main Residence Nil Rate Band | -£175,000 |
| Available Main Residence Nil Rate Band of spouse | -£175,000 |
Chargeable estate |
£750,000.00 |
| IHT at 40% | £300,000.00 |
Gift property to your children
Another option may be to gift the rental properties to your children. A gift of any of the rental properties can be made to your children at any time. The consequences however would be:-
- An immediate charge to Capital Gains Tax (CGT) as the transfer value is always deemed to be at the market value at the time of the gift. This will now have to be reported and any CGT paid within 60 days.
- A loss of the rental income. Once gifted you can no longer receive any of the rental income otherwise this would become a Gift With Reservation of Benefit and would fall back into your estate for IHT purposes. This is a common misconception many landlords have and it is only when they have passed away that their beneficiaries are left facing having to find what can sometimes be a substantial IHT charge. Normally the only options are to sell or re-mortgage the property to ap the IHT.
- You would need to survive for 7 years for the asset to fall entirely out of your estate for IHT purposes.
- Your children may not wish to have ownership in their personal names as the income would push them into a higher tax bracket or they are already higher rate taxpayers.
- There is limited protection of the asset from attack by future partners of your children in the case of divorce or other vexatious claims.
- If there is a mortgage lender in place permission will need to be obtained for the transfer. This is unlikely to be given so your children will need to apply for mortgages and it therefore realistically restricts you to property that has no mortgage.
All in all, this option not a very appetising one for many landlords.
Nonetheless, if there is no outstanding mortgage on any of the properties your children would be able to acquire ownership without having to pay any SDLT. So this might be a way for you to help them in to property ownership with just a CGT charge payable by you.
Transfer to a Discretionary Trust
This could be an option for some landlords but you should be aware of the following limitations:-
- You would need to survive for 7 years for the asset to fall entirely out of your estate for IHT purposes.
- If there is a mortgage lender in place permission will need to be obtained for the transfer into the trust. This is unlikely to be granted and it therefore realistically restricts you to property that has no mortgage.
- A maximum of £650,000 (per married couple) can be transferred without incurring an immediate 20% tax charge on any excess above £650,000. A further £650,000 can then be transferred after 7 years and so forth. For someone wishing to transfer say a £1m portfolio this would require them to survive at least 14 years to eliminate the IHT.
- The Capital Gains Tax on a transfer to a trust can be held over and the asset passed out to your children who also agree to the CGT holdover. This however is merely kicking the can down the road for your children to deal with. If your children wish to sell the property, they will face CGT based on your original purchase price.
- Rental income profits in a trust are taxed at 45%
- There will be IHT exit charges if the property is to be transferred from the Trust to the children in the future
- There will be a 10-year IHT charge on the assets held by the Trust in excess of the nil rate band of £650,000 at a maximum rate of 6%. This is repeated every 10 years for the lifetime of the Trust and can therefore become quite substantial over time.
- The Trust will need to register with HMRC and will need to complete a Trust Tax Return each year
Sale and re-investment
You may wish to consider a sale of the properties and a reinvestment of the capital gain into a Business Property Relief Investment portfolio. Note that it is only the gain that needs to be re-invested. The original purchase price can be retained without charge.
The investment would need to be held for a minimum period of 2 years after which the investment can be passed on to beneficiaries on death with reduced IHT payable. However, Capital Gains Tax is still payable on any sale so a realistic assessment should be made as to the cost/benefit v the risk. Many of the investment vehicles are listed on the AIM or Footsie 350 listing. The risk is the shares may drop in value during your lifetime or the company itself fails and is liquidated in which case you will have lost everything. It is therefore important that you seek independent financial advice before considering this option.
In the tax profession, Inheritance Tax is known as the tax of choice. That is, you can choose to pay it or not pay it. By taking advice early or as soon as possible an effective Inheritance Tax plan can be put in place to help you avoid Inheritance Tax and ensure your wealth can be passed on to the next generation and protected for the generations to come.
