Do you own assets that will eventually be passed on to your children?
Are you worried about inheritance tax?
The problem — capital gains tax (CGT) & inheritance tax (IHT)
Many parents throughout the UK wish to transfer assets to their children now to avoid inheritance tax (IHT) in the future and we receive many calls from clients and non-clients who have heard about lifetime transfers. Basically, if you transfer assets up to the IHT threshold and survive for seven years after the transfer, then that transfer will not form part of the IHT liability upon your passing.
Unfortunately, however, parents still have to pay capital gains tax (CGT) on any transfers made between them and their children, even if the transfer is a gift. HMRC deems that any gifts of assets are liable for CGT at market value. If an asset is valued at £100,000 and is given to a child for no consideration, then the £100,000 is what is used to determine the CGT liability.
This causes people a huge headache as they know that their assets may be subject to IHT if they do not act quickly, but even if they do, their assets are subject to CGT.
Can you relate to the above?
A real life client example — John passing assets to his son James
For the purpose of this article we are going to name my client John to protect his identity. John has £1.5m of assets, of which £1m is in residential properties and £500K is the net asset value of his trading business. He wishes to set up his son James (20) in business to give him a head start in life as university is not on the agenda for him.
John thinks about transferring all of the residential properties and the business to his son so that he can leave the UK for a sunnier climate. John knows that making such transfers will help him mitigate IHT if he survives for seven years afterwards. At the time of writing the transfer limit was £325,000 and the IHT threshold upon death is also £325,000. This means that James would have to pay 40% tax on any excess over £650,000. Ultimately this would mean selling off some assets.
Transfers to mitigate CGT and IHT
As we have identified, there are £500,000 nets assets in his business. John can transfer the business to his son and claim gift relief, meaning that John does not pay CGT but his son will have a deemed cost of £0. This means that James will have to pay more CGT in the future — he will pay CGT not only on the increase in value of the business during the time he has owned it, but also the deferred amount due when it was gifted to him. An example of how gift relief works was included in this article.
When it comes to the residential properties, John considers a transfer up to the lifetime transfer value of £325,000, half of the residential property value, but then realises he would have to pay CGT upon such a transfer.
Remember, however, that John has an annual capital gains exemption of £11,100, which means that any gain below this amount would be CGT-free. John could therefore consider transferring one or two properties to his son per year to take advantage of this allowance.
Practical steps you should now take to mitigate IHT and CGT
It is one thing to understand the theory but it is another to put it into practice. This is why I have written a step-by-step guide to implementing this strategy:
- Identify the nets asset value of your trading business assets and transfer those using gift rollover relief
- Transfer assets over time that are not trading assets to utilise your capital gains exemption
If you want to understand how to implement this strategy or to discuss other finance/tax questions then please book some time with us using the below calendar
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