How to Approach Property and Inheritance Tax

Property is often the most valuable asset in a deceased person’s estate. However, there are some tax complexities around property that do not apply to other asset types.

This guide covers the main IHT implications of owning property.

Inheritance Tax: A Brief Summary
To understand how property fits into your estate plan, firstly, we need to consider the basics of IHT. This works as follows:

• UK individuals have a nil rate band of £325,000. Estates below this level are not subject to IHT.
• Assets can pass to a spouse without IHT implications. On second death, both nil rate bands are available to set against the estate (a total of £650,000), minus the value of assets passed to any other beneficiaries on first death.
• Gifts made in the seven years before death are normally added back into the estate. There are some exceptions to this, for example if the gifts do not exceed £3,000 per year. Charitable donations are fully exempt.
• The estate over and above the nil rate band is taxed at a rate of 40%. The rate may be lower than this if the estate includes business assets or if any of the estate is left to charity.

The Residence Nil Rate Band
The Residence Nil Rate Band (RNRB) was introduced in 2017 to reduce the impact of IHT where a main residence forms a significant part of the estate.

This can extend the nil rate band by up to £175,000 per individual. For a couple, this amounts to £350,000 if the property is owned jointly. There are a few conditions:

• The RNRB is capped at the value of the property. If it is worth less than £350,000, the full relief cannot be claimed.
• The property must be passed to direct descendants. This means that you cannot claim the relief if, for example, your property passed to your siblings or their children.
• For estates valued at over £2 million, the relief is gradually revoked at a rate of £1 for every £2 over the threshold. This means that estates valued at over £2.35 million (£2.7 million for a couple) do not receive the relief. However, unlike many other aspects of IHT planning, making gifts shortly before death can be effective for restoring eligibility for the RNRB.

The situation becomes a bit more complex if you have downsized your home, moved into residential care, or if your will includes provision for assets to pass into trust. Advice is recommended in these scenarios.

Gifting Property
Between the nil rate band and the RNRB, a married couple can pass up to £1 million to the next generation before IHT becomes a consideration. However, where the property does not meet the conditions, or is worth significantly more than this, additional planning may be required.

Making gifts is usually an important part of a well-rounded estate plan. Gifts of up to £3,000 per year, or gifts from surplus income are immediately exempt and larger gifts normally drop out of the estate after seven years.

Gifting property is trickier, partly because the value is usually well above the regular gifting exemptions.

A gift of property to an individual is a potentially exempt transfer (PET). This means that it will drop out of your estate after seven years. If gifts in the seven years before death exceed £325,000, the resulting tax will be reduced by 20% per year from the end of year 3 to year 7.

Gifting the property to a trust is a chargeable lifetime transfer (CLT). This can incur an immediate tax charge of 20% if the gift exceeds £325,000. Additionally, trusts pay a higher rate of tax than individuals, which can complicate matters if there is rental income or the property is later sold at a profit.

To be effective for IHT planning, the gift must be absolute, and you cannot continue to make use of the asset as you would if you still owned it. This means you also give away the right to live in the property, receive rental income, or use the property as a holiday home.

If you continue to use the property, one of three scenarios may apply:

• The property could be considered a ‘gift with reservation’ and will be added back into your estate.
• An annual pre-owned asset tax (POAT) charge may apply.
• Alternatively, you will need to pay a commercial rate of rent.

Additionally, if you need to pay for care, the value of the property may be taken into account for means testing purposes.

It’s a good idea to seek tax and legal advice if you are considering giving away a property, particularly your main residence.

Property as a Business
If you own rental properties, the options to reduce tax are limited. For tax purposes, buy-to-let properties are treated less favourably than other business assets in general. IHT planning is no exception.

Property companies are considered to be investments rather than trading businesses, which means that your estate cannot claim business relief. There are some exceptions, for example, if you provide significant other services to your tenants, for example, certain types of holiday accommodation.

However, if your property is held within a company, it can be easier to gradually pass ownership to your beneficiaries. This is because you can transfer a certain number of shares rather than full ownership of a property. These transfers are still PETs, however in some situations the shares (i.e. the loss to your estate, and therefore the value of the gift) may actually be worth less than the value of the properties. This is a complex area and you should seek tax advice before proceeding.

Paying the Tax
In many cases, it is not possible or practical to avoid IHT on property. Additionally, if the property is your main asset, the beneficiaries may need to sell it in order to pay the tax.

Another option is to set up an insurance policy to cover the tax. If the pay-out is directed into a suitable trust, it could bypass your estate, avoiding additional IHT. The regular premiums are treated in the same way as other gifts, which could reduce your estate further if you remain within annual allowances.

There are a number of options for passing on property tax-efficiently, however there are an equal number of pitfalls that could result in paying even more tax.

Please do not hesitate to contact a member of the team to find out more about estate planning.