Passing property to loved ones can be tricky, especially if you own multiple properties or buy-to-let properties. By taking the appropriate steps and planning for the future, you can not only mitigate your capital gains tax (CGT) but inheritance tax (IHT) for your family as well. Here we’ll go through transferring ownership of property from parent to child, including ‘gifting property to children’, and the options that take advantage of capital gains tax and inheritance relief.
The lowdown on Capital Gains Tax (CGT) and Inheritance Tax (IHT)
For the 2020/21 tax year, CGT on a residential property is 18% for a standard rate taxpayer and 28% for a higher rate taxpayer. This tax is on any gain made over £12,300 for individuals and personal representatives and £6,150 for trustees of settlements.
IHT is another tax to think about as it’s a tax levied on your estate when you die and includes possessions, properties, and cash in the bank. A tax of 40% will be liable on all assets valued at more than the £325,000 IHT threshold for single adults or £650,000 for married couples and civil partners.
Making provisions for estate planning can help you optimise the value of your property while protecting your children’s future income. We take a look at a few options that take advantage of CGT and IHT tax relief available to parents wanting to pass on property to their children.
Related: Changes UK landlords need to be aware of for the 2019-2020 tax year
Related: 10 ways to cut your tax bill
Gifting a property
Gifting a property to your children involves taking a capital gains tax hit now to help your children avoid having to pay an even larger sum for IHT later.
To take the hit and avoid a larger bill for IHT later, CGT will have to be paid on the difference between the price when you bought the property and the market value when you give it away. HMRC declares the parent received the market value even if the property was gifted for free.
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If you survive for seven years after gifting the property, the asset will be removed from your estate and no IHT will be due. This is called a “potentially exempt transfer”. In order for this to work, the gift must be made with no strings attached, meaning the gift can’t come with conditions or bring benefits to you in some way. Otherwise, it’ll be considered a “gift with reservation of benefit” and will remain in your estate.
You can rent the property from your children if you still need or want to live there, so long as it’s at the market rental rate, but they will likely have to pay income tax on the rent they receive from you.
If you and your children both plan to live in the house, another way of transferring ownership of property from parent to child and minimising IHT is by giving half the house to your children and splitting the bills evenly. Their half of the house would then not be subject to IHT so long as at least seven years pass before your death.
Transferring a property into a trust
Homeowners and buy-to-let landlords with children could benefit from transferring their property into a trust. This strategy is only possible when a mortgage-free asset is transferred to an adult child. IHT will apply for properties valued over £325,000. Therefore, the ideal property would be valued below the IHT threshold.
You can use a trust to manage a property until your children become of age. This can help you reduce your own income tax, reduce the asset value for IHT reasons, and provide an income for your children when they become adults.
This tax relief is possible by using Section 260 of the TCGA legislation. It’s best to wait at least three months before transferring ownership of property from parent to child within a trust. This ensures it’s possible to obtain CGT holdover relief. Exit charges are another factor to calculate and consider. To complete the process, fill out and submit Form IHT100 within 12 months of the transfer.
Giving shares in a limited company
If you’re a buy-to-let landlord, you might think about passing on shares in your business to avoid IHT, instead of passing on the properties you own. This is possible, but as this Property Geek article reveals, it’s more difficult than you might think.
Business Property Relief is a relief that removes IHT from a business or an interest in a business by 50% or 100%. However, companies wholly or mainly involved in making or holding investments can’t claim this relief. To get around this, you could steer the company into areas eligible for Business Property Relief, potentially enabling you to gift shares that will not be IHT liable.
Related: Should You Incorporate or Form An LLC? 2019 Updates
There are a few options to consider when transferring ownership of property from parent to child if you are seeking to minimise CGT and IHT, whether you’re a buy-to-let landlord or a homeowner. The best thing to do is plan in advance and decide which option works best for you and your family.
Calculating capital gains and inheritance taxes can be complex, so it’s advised that you seek professional advice from a financial advisor or property tax specialist.
To get an up-to-date valuation on your property or rental property for tax purposes, visit portico.com/valuation