Gift Property to Children into a trust without paying Capital Gains Tax
Gifting investment property to children without paying Capital Gains Tax will be the main discussion points in this article but will cover other relating subjects.
You may be interested in our main article on Capital Gains Tax rates and allowances. You may also be interested to know how more about our services to help reduce your Capital Gains tax liability when you sell the property investment.
You would transfer BTL properties when you create a trust and back again to your adult child for the following reasons:
– Reduced income tax for the parent (especially if they are a high rate taxpayer)
– Provides an income for the adult child
– Reduced the asset value of the parent for IHT purposes
You may want to transfer properties from your estate to your children but do not wish to pay Capital Gains Tax and would like to avoid Inheritance Tax (IHT). Ordinarily, there will be a Capital Gains Tax liability if you wish to transfer a Buy To Let (BTL) property to your children. This is because HMRC deems that the market value of the property was received by the parent, even if the property was given away for free. Capital Gains Tax will be based on market value, less purchase price, less capitalised refurbishment costs.
The rate of Capital Gains Tax to be paid on BTL properties is 18% for basic rate taxpayers and 28% for high rate taxpayers after taking out their £11,700 Capital Gains Tax annual allowance. Our property accountants are on hand to provide you with guidance on this matter.
We will answer your questions about Transferring properties to children to avoid CGT and IHT
– What are the tax implications of transferring a buy to let property to a child or family member?
– Will I need to pay Capital Gains Tax on the gifted property is passed to my children?
– What are the inheritance tax implications of gifted property to children?
A step by step guide of how to transfer properties to children without paying CGT and IHT
1 – Identify assets/property that has a value of less than £325,000 (which is below the IHT threshold). Anything above this value will be subject to IHT at 20% (if paid by the settlor)
2 – Transfer the property into a Trust (debt/mortgage free) and calculate the IHT liability
3 – After three months of the trust being created transfer the assets/property from the trust to the adult child and calculate the IHT exit charge
4 – Complete and submit the IHT100 form within 12 months of the said transfer
Why you should read this article about gifting buy to let properties to children or another family member
Section 24 mortgage interest relief cap has had a major impact on the tax affairs of parents. We also know that parents wish to help their children get on the property ladder.
There are many advantages of transferring or gifting a buy to let property to children.
– The buy to let asset will no longer be income-generating, as such the amount of income tax paid by a parent is reduced
– You help get your children onto the property ladder and help to reduce the eventual buy to let inheritance tax problem. This is achieved by gifting property to children. You can, of course, gift assets to another family member
– You do not wish to pay Capital Gains Tax on the transfer of a buy to let property that you have gifted the property to a loved one and a family member
Capital Gains Tax avoidance using a trust TCGA S.260
We will now focus on the subject of transferring a BTL property into a legal structure. You create a trust whilst avoiding Capital Gains Tax and IHT. The piece of legislation that we will focus on is Section 260 of TCGA. Always make sure that you take legal advice from a qualified solicitor that knows how to deal with property transactions.
If the trustees pay, the rate of tax is 20% over and above the IHT allowance (£325,000 per person). Suppose the settlor pays the Inheritance bill. Tax instead of the trustee, this means there will be an increased loss from the settlor’s estate. These calculations are complex as can be seen on HMRC’s website and legislation pages.
This is made a lot more complicated if transfers have been made in the past 7 years. Added to this is the additional IHT reliefs for gifts, weddings etc. We would suggest that you speak with a tax specialist about this. You gain confidence by speaking with one of our property accountants on this matter.
Can I put my house into trust for my children?
One of the ways that you can mitigate Capital Gains Tax (CGT) and Inheritance Tax with the use of trusts.
That said you do not need to use a trust of you wish to place your house into a trust. Especially if you have always lived in that property. The reason being is that you can gift the house to children without Capital Gains Tax.
Capital Gains Tax is only chargeable if you have a taxable gain. There are no taxable gains on gifting your home to children as you benefit from Private Residence Relief (PRR).
As a rule of thumb, you can gift your home to children and pay no Inheritance tax. This is provided that you live for seven years or more.
Transfer of buy to let property to children using trusts
You need to be aware that the above strategy will not work if you are transferring assets to a minor. This is because any assets passed from parent to a minor remains an asset of their estate and any income derived from the asset is treated as income for the parent. As you can see that this only works whereby you transfer assets to an adult child.
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IHT liabilities & Exit charges by transferring assets into the trust and then onto the child
It is essential that you wait at least three months before you transfer an asset within a trust to your child or a family member. You will need support from a good solicitor to create a trust. All of our accountants suggest that their clients should take legal advice in conjunction with our tax advice before proceeding with any action plan.
Only then would you transfer the property out of the trust within 3 months of the 10 year anniversary. This will ensure that Capital Gains Tax holdover relief is available.
Once you decide to transfer the asset from the trust to your child, you will need to consider exit charges. The exit charge is another form of tax over and above the 20% paid. The value of the asset is the net asset value of the property.
This is a little more complicated so we will use an example:
– £450,000 asset value
– £325,000 less the nil band rate for IHT purposes
– £125,000 asset value chargeable to IHT on transfer into a trust
– £25,000 IHT paid (£125,000 times by the 20% IHT rate)
Calculation of exit charges of moving trust assets to children
We are now able to calculate the exit charge rate as follows:
– £25,000 IHT liability paid on the transfer
– 5.56% is the notional tax paid of £25,000 divided by the asset value of £450,000
– 1.332% charge rate being 5.55% times by 30%, times by 32 being the number of complete quarters of the trust set up, divided by 40 (10th anniversary of the trust being created)
– £6,000 being the exit charge of 1.332% times by the asset value of £450,000
As you can see that the total IHT liability on transferring an asset of £450,000 into a trust is:
– £25,000 IHT on transferring the asset into a trust
– £6,000 IHT exit charge
The total tax on transferring a £450,000 asset is £31,000. This is just 6.89% of the asset value.
Please note that any additional transfers would be taxable without the £325,000 lifetime allowance as it has already been used up.
There would be no IHT liabilities if the asset was worth less than the £325,000 IHT allowance, provided that no previous transfers had been made. This is a complex area. We would suggest that any numbers are checked by one of our property accountants.
Capital Gains Tax for the child on disposal of the asset
Please be mindful that the above strategy is only deferring the Capital Gains Tax liability. The above example shows an asset transfer of £450,000 but because the father used holdover relief the deemed cost to the son is the original purchase price of £300,000.
3% SDLT surcharge considerations
Your child would have to pay the 3% SDLT surcharge if the child does not already have a home and you transfer the property to them out of trust.
Potentially Exempt Transfer also known as PETS and Inheritance Tax bill
A potentially exempt transfer (PET) means that the person passing an asset to a family member may still pay IHT if they die within 7 years of the original gift.
A PET is fully exempt if the donor survives 7 years from the date of the gift. A PET will become a chargeable transfer if the donor dies within 7 years of making a gift. On the death of the donor within 7 years, an IHT charge will be levied. Any tax will be payable by the recipient of the gift.
The 7-year rule
If there is an Inheritance Tax bills to pay, it’s charged at 40% on gifts given in the 3 years before you die.
Gifts made 3 to 7 years before your death are taxed on a sliding scale known as ‘taper relief’.
Years between gift and death Tax paid.
– less than 3 years = 40% IHT chargeable
– Between 3 and 4 years = 32% IHT chargeable
– Between 4 and 5 years = 24% IHT chargeable
– Between 5 and 6 years = 16% IHT chargeable
– Between 6 and 7 years = 8% IHT chargeable
– After 7 years = 0% IHT chargeable
You do need to take legal advice from a qualified solicitor or financial advisor to ensure that you time your gifts to children or another family member without paying IHT
A note on life insurance and the payment of the Inheritance Tax bill
Many clients use life insurance policies as a vehicle to pay Inheritance Tax bill if they were to die within the 7 year period.
The life insurance policy can, of course, be used for all assets subject to inheritance tax.
There are many forms of life insurance. Be sure to put the life insurance policy into trust for the beneficiaries.
Many UK landlords make the mistake of putting the life insurance proceeds into their own estate. The money received after death is then subject to inheritance tax at 40%. This means that the ultimate beneficiaries will only see 60% of the life insurance policy.
Make sure that you get good legal advice when identifying the right type of trust to be used for the life insurance policy. The world of trusts may be very confusing, and it is possible that you could choose the wrong type of trust and pay far more IHT than you expected.
Buy to let mortgage comments:
The use of trusts for tax planning is not uncommon in the world of property – and for a good reason.
But, trusts can cause untold problems with mortgage lenders.
Simply put, if you are noted on the land registry as the owner of the property, you’re effectively named on the mortgage in the eyes of the lenders – and that means you alone must receive the rental income and pay the mortgage. You are 100% responsible and liable for the debt.
As noted above by our friends at Optimise, one such strategy to avoid any debt repayment issues with lenders is to… well, repay the debt.
Let’s say you have a residential property which is unencumbered and free of mortgage debt, but you also have outstanding mortgages on your buy-to-let properties.
We can help you secure the best remortgaging deal on your residential property, releasing tax-free equity which can then be used to repay your buy-to-let mortgages in full.
Speak with us today at https://www.spvmortgages.co.uk/contact-us/
You may also be interested in the below relevant articles on Capital Gains Tax
A special note for those that need to file a 1040 tax return to the US
Now that you have understood the UK tax position of Capital Gains Tax and Inheritance Tax, you may now need to consider the US tax position when submitting your 1040 tax return to the IRS.
It might be worth reading the article on Capital Gains Tax and Inheritance Tax that has been written by Purser Tax, a company that helps people save tax across the Atlantic.
Please note that you may have paid tax in the UK, but you may need to pay additional tax in the US to the IRS. Please do not worry as there is a tax credit available when you submit a 1040 tax return using the IRS 1116 form Foreign Tax Credits.