For many, the family home is the most significant asset – both in terms of its financial value and because of the strong emotional ties it holds. This, together with a complex set of anti-avoidance tax rules, mean it can be difficult to consider how to manage family property when it comes to Inheritance Tax. Claire Spinks, our Head of Tax Technical and Development, explores what opportunities may be available for lifetime planning and at what cost.
Inheritance Tax (IHT), which sits at a staggering 40%, is one of the largest rates in the UK tax arsenal. And when it comes to the family home, which many people hope is an appreciating asset, the associated IHT liability can rise silently, with little or no ability to influence the resulting bill. Since the launch of the Inheritance Tax Act, there have been various solutions introduced to help reduce this tax, although many of the exploited loopholes have now been closed or new legislation passed to offset any potential tax savings. So, what are your options?
Starting to plan for IHT
In any IHT planning exercise, the starting point is always to take a look at what your position would be if you did nothing. Considering a few key points (such as your Estate’s value, including the value of your home and how your assets pass to the beneficiaries under your Will) gives a reasonable estimate as to the IHT bill you’ll face, and which may then later face your spouse if you are married or in a civil partnership. For some, this picture might seem acceptable, especially if other assets within your Estate are set to pass more efficiently due to various tax reliefs available.
Do any tax reliefs apply to property?
In terms of tax relief, there are certain scenarios in which the family home and its beneficiaries will benefit from the Residential Nil Rate Band (RNRB). Introduced in 2017, the RNRB has sadly stayed frozen at £175,000. Together with the other key IHT relief (the standard Nil Rate Band) it’s worth noting that neither has kept up with inflation or growth across the rising UK property market. As a result, you shouldn’t depend solely on these reliefs, which currently stand at £1m combined for a married couple. Don’t forget too that the RNRB will be withdrawn completely if your Estate exceeds £2,350,000 (£2.7m if you are in receipt of a spouses unused RNRB). So, if these bands don’t have the desired effect in terms of tax savings there might be reasons to consider other options.
To plan or not to plan?
When given the opportunity to potentially save 40% tax on a large value asset the issue is pretty simple – whether it’s better to plan or not to plan.
As with most tax solutions a universal approach doesn’t exist. To understand whether a plan is needed it’s worth considering whether you’d like the family home to be retained by the next generation, and if so, what that scenario looks like. There are some important things to think about, for example you may want to pass on the family home to your children during your lifetime but still live there until your death. Sadly, taxes may still be a factor in this situation and HMRC have specific legislation to stop the tax benefit from an asset being gifted on whilst the benefit of it is retained. There are however a few exemptions which can make a lifetime gift efficient for IHT purposes, some of which involve minimal use, joint occupation, and/or market value rents being paid for continued use.
With all aspects of setting up IHT solutions it’s worth considering how future proof your plan can be. For example, HMRC may introduce new legislation which could undo the strategy you’ve put in place or the equity in the home might be needed later for care home fees. You may also want to move or change the property and it might be that the individual who you’ve gifted the property to has a change of circumstances. For example, two parents may choose to give their £1m family home to their daughter, whilst paying her rent to live there. Whilst this plan might be effective for IHT reasons things could quickly become unstuck. If the daughter then marries and subsequently divorces, she could be forced to sell the home, where her parents still live, to settle the divorce.
Don’t forget hidden costs
It’s worth bearing in mind that family homes rarely produce an income so any costs you’d need to pay for advice or administering any IHT solutions will be something which you or other family members might need to absorb.
Taxes to be aware of
When it comes to gifting your property there are a range of taxes which you might need to consider too:
- IHT – exemptions are available, as noted above, when it comes to gifting. Passing money or assets to friends or family is a potentially exempt transfer. No IHT is payable if you survive seven years after doing so. But remember that you can’t necessarily retain the benefit yourself, perhaps by continuing to live in the family home on your own after putting it in another’s name. Exemptions exist, but these are complex so it’s worth talking to a specialist tax adviser.
- Capital Gains Tax – any gifts of property are classed as a ‘chargeable event’. So, whilst the family home may benefit from principal private residence relief and there will be no immediate Capital Gains Tax (CGT) cost, is the position more costly from a CGT perspective overall? If left as part of your Estate, then the property would benefit from any market value uplift on death. This won’t apply to a gift made during your lifetime so it’s worth considering whether the new owner of the property will suffer more CGT in the long run.
- Stamp Duty – any gift of property shouldn’t generate a liability but if there is an outstanding mortgage this may need to be a consideration.
- Income Tax – some anti-avoidance rules might mean you fall foul of Income Tax, particularly if any rent is being paid by those living in the property which might be required to benefit from some of the exemptions.
The most important aspect is to properly understand the position of your Estate and personal circumstances. Some solutions might work, whilst others could throw up issues. If a plan isn’t shaping up well or leaves you cause for concern it might be possible to plan to reduce tax in other asset areas – perhaps through charitable gifts, use of Trusts, or using investments for which business property relief would be available.
To discuss any aspect of your Estate planning, or IHT, please contact your nearest office.