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Inheritance tax: Benefits and banana skins

by | Apr 16, 2019 | Inheritance tax

Inheritance tax is a complicated area, but with the right advice you can ensure the best outcome for you and your family. At Foxley Kingham and GKP we have years of experience dealing with issues arising from inheritance tax. Alfie O’Dell discusses some of the most common issues our clients face.

Inheritance tax – personal

Tax free gift

There is no tax payable on a cash gift to a family member as long as you live for at least seven years after the gift has been given. However, if you do not live the required seven years the gift may be liable to inheritance tax. The tax will be calculated on a sliding scale.

This can be useful forward planning if you are in good health, have surplus funds and, for example, want to help children or grandchildren to get onto the property ladder or bolster their pensions.

Passing on a property

If you wish to gift your children a property, no inheritance tax is payable under the seven year rule as detailed above, but you may find yourself with an unwanted capital gains or stamp duty liability. There is no relief from capital gains for gifts (unless it is a business asset) and stamp duty would be due on any outstanding mortgage on the property. However, with careful planning, it is still possible to gift property in a tax efficient manner by using a trust.

Gifts to charity

There is no inheritance tax to pay on gifts or bequests to charity, and if you leave more than 10% of your net estate to charity you may qualify for a reduced inheritance tax rate of 36%.

Inheritance tax – business Business

Property Relief

If you run your own business, chances are it may qualify for Business Property Relief, (BPR) an important relief that means the value of the business is relieved from the charge to inheritance tax, either partially or completely. Usually you can get 100% Business Property Relief on a personal business or shares in an unquoted company, and 50% BPR on land, buildings or machinery owned personally and used in a company or partnership. However, there are a number of conditions, so it is important not to fall foul of these and lose the benefit of BPR.

What kind of business qualifies?

Businesses have to be trading companies to qualify for BPR. Investment companies (including property investment companies as described in the last edition of ProActivity) won’t qualify as trading companies and incorporating your property portfolio won’t automatically remove it from the grip of inheritance tax.

You also need to be careful if the business is carrying large cash balances as this could be challenged by HMRC as to whether this is an investment rather than trading activity. If large cash balances are present, you need to document why they are being held. For example, are they to provide a reserve or buffer in turbulent economic times? Are they savings towards future commercial property, or to provide capital for new business lines or developments?

Other BPR restrictions

Relief only applies if you have owned the business or asset for at least two years and BPR can’t be claimed if the business is in the process of being sold. Whilst this may seem straightforward enough, some shareholders agreements have clauses that give business partners an automatic right to buy shares in the event of death. If the clause is binding it constitutes a sale, and BPR is lost. However, this can be avoided by the careful use of options rather than a binding clause.

When incorporating, a common strategy is to leave owned premises as owned personally, particularly if it is mortgaged and including it in the incorporation could prove expensive and problematical.

Just be aware that if the property is then rented to the company for a full market rent, (as is commonly required by the lender) it is an investment asset not an asset used by a business and so will not qualify for BPR.

Inheritance tax and your home

Leaving the family home to loved ones is something that a great deal of us plan to do. However, there are significant inheritance tax issues that come with such a bequest. In many cases, much of the value of an estate is tied up in the home and therefore it is difficult to make the gift tax efficient. If you remain in the family home, you and your family will not qualify for any inheritance tax relief on the value of the property. And if you give it away, you cannot remain in the home.

One option could be to gift the home to your loved ones then live in the home while paying market rent to the new owners, although this could require significant financial resources.

Another option could be to use the property to raise equity release finance, then give the money to your beneficiaries. In this instance you must live for seven years to avoid inheritance tax. However, this form of financial management will not sit comfortably with everyone.

Residence nil-rate band

An additional residence related nil-rate band is being phased in that could ultimately increase a personal inheritance tax threshold by up to £175,000 in 2020/21. The extra band is per person, and as with the ordinary nil-rate band, spouses would benefit from two allowances, transferring any unused portion between them.

Tax tip: It is important to note the residence nil-rate band is limited to the value of the property. For instance, if in the previous example the family home had a value of £300,000, the amount of residence nil rate band would be restricted to £300,000.

Already downsized?

All is not lost If someone has already downsized or sold the family home, for example to cover care home costs, they can still benefit from the new band the property sold would have had, had the individual still owned it at point of death and the downsized property or assets form part of the estate being passed onto a direct descendant.