If you have invested in rental property and are considering future inheritance tax planning options, you may be wondering how best to deal with these assets. Gifting is a good strategy for reducing your IHT liability, but in the case of investment property, there are tax consequences. However, it may still be worthwhile, provided the tax implications are understood. Here is what you should understand about gifting investment property to family members.
Firstly, transfers between spouses do not attract tax so an investment property may be gifted to your spouse without any tax consequences, apart from SDLT on the value of the mortgage assumed (as below).
Gifts to children could incur tax as follows:
Stamp Duty (SDLT)
Gifting a property will involve a change of ownership at the land registry just as if it had been sold on the open market. If there is an outstanding mortgage on the property, stamp duty will be payable on the mortgaged amount taken over by the recipient, at whatever the current rate is; if the mortgage is below £125,000, no stamp duty will be payable, whereas if the outstanding mortgage is £500,000 for example, SDLT will be charged at 5%.
If the recipient is already a property owner, they will also have to pay the stamp duty surcharge. For property between £40,001 and £125,000 stamp duty will be levied at 3% and returning to the original £500,000 example, the extra 3% means a rate of 8% will be payable.
Capital gains tax
Depending on the uplift in value, capital gains tax on a gifted investment property will be payable by the donor in the same way that they would pay CGT if they sold it to a third party. This is calculated according to the increase in value between the original purchase date and date of transfer (which, to a connected party, is treated like an open market sale). The rate at which CGT is levied will depend on the donor’s income – basic rate taxpayers will pay 18% rising to 28% for higher rate tax payers, based on current tax rates for residential property investments.
If the donor is financially in a position to do so, they may defer the capital gains tax payable by making a tax efficient investment – for instance in an EIS (enterprise investment scheme) or SEIS (seed enterprise investment scheme) approved company. Certain time limits and conditions apply but it is certainly something to consider.
Inheritance tax
If the property is gifted outright with no reservation of benefit and the donor survives the gift for over seven years, it should qualify as a PET (potentially exempt transfer) and no inheritance tax will be payable.
What about a trust?
Alternatively, the investment property could be gifted onto a suitable trust to remove it from the donor’s estate and also, looking into the future, the recipient’s estate, leaving it for the benefit of descendants. A gift onto trust is not a PET for inheritance tax purposes however, but a chargeable lifetime transfer, so any value that exceeds the available lifetime exemption (generally £325,000) will be charged to IHT at the lifetime rate of 20%.
Trusts attract income tax at the rate of between 38.1% and 45% on investment income, however this tax credit can be passed onto lower tax-paying beneficiaries, enabling them to claim tax refunds.
Whilst establishing a trust can be good from the point of view of control, it can also be costly, both to set up and manage and when it comes to establishing trusts, there are no hard and fast rules but many pros and cons, which should be explored for every case individually.
Ultimately if you have built up an investment property portfolio and are considering the inheritance tax implications, be mindful of the different tax traps that exist. Gifting this type of property is not straightforward and the tax consequences must be thought through.