The property gift that may carry a sting in its tail
THIS week we look at the tax position where a buy-to-let property is gifted.
This is a complex area but is an option worth exploring.
For individuals of a certain age, seeking ways to reduce their family’s exposure to inheritance tax (IHT) becomes a priority and that applies when it comes to investment property.
Consideration may be given to making a gift of a buy-to-let property to adult children but this can give rise to an unexpected capital gains tax (CGT) liability for the unwary.
So here are some tips for those who need to exercise caution: the general rule is that where you make a gift of a capital asset, such as a property, it is treated for CGT in the same way as if you had sold the property at its market value. Therefore, even where you have not actually received any money, you still can have a tax liability.
Let’s look at an example to illustrate how this works:
A married couple decide to make a gift of a jointly-owned buy-to-let property to their adult children. The property was bought 10 years ago for £80,000 and has a current value of £200,000. Therefore, the gift gives rise to a “deemed” capital profit of £120,000 and this is fully taxable to CGT.
After deducting each individual’s tax-free annual exemption of £10,600, the tax liability would be almost £28,000, assuming the couple are higherrate taxpayers.
So is there any way of avoiding this charge? Well, it might be possible to arrange the gift to be made to a trust that is created for the benefit of the children.
The key advantage of using a trust is that “hold over relief” is available, which means that the tax liability on the gift is avoided and the trust picks up the property at its original cost of £80,000.
Were the property to be sold by the trust then the capital profit is wholly taxable on the trust at 28 per cent, but at least the liability is deferred until a sale of the property.
Also, the terms of the trust can be flexible enough to allow the trust’s property to be appointed out to the beneficiaries at the discretion of the trustees, which means that at some point the property can be transferred out to the children absolutely, which would therefore achieve the outright gift to them that had originally been planned for.
Again, on the transfer out of the trust there is the availability to “hold over” the gain, with the children then picking up the property at its original cost of £80,000. The children will be liable to CGT only when the property is eventually sold.
It is necessary to briefly consider the way in which the gift is dealt with for IHT purposes. With an outright gift to the children, the value of the gift is potentially exempt from IHT, known as a “PET”. The value of the gift becomes fully exempt provided that the parents live for at least seven years from the gift.
Conversely, a gift to a trust is immediately chargeable to IHT but each individual is able to make gifts having a value of up to £325,000 in a seven-year period before an actual tax liability would arise.
The trust is a separate entity for IHT purposes and a detailed exploration of those rules is beyond the scope of this article, but suffice to say that for as long as the value of the trust assets remains below the £325,000 limit (or £650,000 where the trust is created by a married couple), there would be no IHT charges arising on the trust.
If you are considering taking steps to reduce your prospective IHT liability, it is essential that you seek appropriate professional advice.