How to Reduce Your Inheritance Tax Risk
It’s not the most cheerful of topics, but at a standard rate of 40% inheritance tax is definitely something you need to think about
What happens to your portfolio after you exit stage right might not impact you massively, but could have a huge impact on the loved ones you leave behind.
None of us are working hard to build up a profitable business only to see a huge chunk of it passed over to the taxman upon your departure. So, along with a panel of experts, we’ve put together a handy guide to give you the lowdown on how to protect your assets when the time comes.
In this episode:
- Chartered Accountant and Chartered Tax Adviser Richard Cunningham talks to us about inheritance tax and how it could impact your property portfolio.
- He gives us an overview on how to best plan for the inevitable, and if there’s anything you can do to best prepare your final tax moves
- Mashroom’s Emi Steadman, who’ll be looking at how to protect your portfolio should the worst happen
- Our very own Sunny Channa, who will be talking us though how inheritance issues can impact your insurance.
Inheritance tax is a topic well worth understanding, because without a clear plan in place of what will happen to your portfolio when you depart, not only could you leave your loved ones with a hefty tax bill, you could also end up with costs to bear yourself BEFORE the worst happens. Ouch.
We’ve been joined by tax titan and Mashroom show regular, Richard Cunningham. A chartered accountant and chartered tax advisor, Richard understands that there are two inevitabilities in life – death and taxes. But, knowing that, inheritance tax needn’t be as painful as you might think.
He’s here to explain the ins and outs to us, and give some guidance on how to plan for this pesky payment.
What is inheritance tax, and how does it impact landlords now?
‘Inheritance tax is a tax on the value of a person’s estate on death. Many people will agree that it’s a pretty nasty tax if you think about it,’ admits Richard.
Let’s say you’re a higher rate taxpayer. You’ve paid 40% tax on your earnings throughout your working life. You then die and they tax you again. There goes another 40%. So, it’s a tax that people are keen to try and avoid if they can.
Are there any exemptions
‘There are some exemptions. You get £325,000 nil rate band, so the first £325,000 isn’t subject to inheritance tax, explained Richard.
‘There is also an extra £175,000 allowance in relation to your main residence if your overall estate is worth less than £2 million. A lot of people will be within that band. But obviously house prices have only gone one way in the last 15 to 20 years, and if you’ve got a big portfolio, it could push you over those limits.’
What if a landlord knows exactly who they want to leave what to, so surely this is an easier way to do things, and would avoid the inheritance tax issue altogether?
‘You can gift up to £3,000 a year to whoever you like without, without that including your estate on death. That’s to any single person or to any number of people. On that £3,000 annual gift exemption, if you don’t use it in one year, the relief carries forward and you can use it in the next tax year,’ said Richard.
‘There’s also what’s called regular gifts out of income. If you do develop a regular pattern of gifts, so let’s say you give your daughter £3,000 a year and you’ve been doing it for the last five years, then potentially that’s outside your estate. There are a couple of things you’ve got to be a bit careful of. It’s got to be a gift out of income, it doesn’t work if you sell a property and use money that you’ve realised from the sale of the property – that’s not your income. What they’ll (HMRC) look at is your taxable income, income that you don’t need to maintain your normal lifestyle.’
Is there any truth in the fact that you can pretty much gift what you like as long as you then don’t die for the next seven years?
‘Yes!’ laughs Richard. ‘Obviously the devils in the detail, but in simple terms, yes. And the way that it works is there’s a kind of tapering effect as well. So from years three to four, 20% of the charge drops off.‘
One of the things to be aware of though is the £325,000 tax free element. When calculating that, the first thing that the revenue does is they apply the gifts that you’ve made against it first. So, if your gifts are under £325,000, you don’t get the benefits of that tapering effect. It’s just netted off the exemption twice.
Main residence issues
‘In most people’s estates, the biggest asset will typically be the main residence,’ agreed Richard. ‘One of the most common questions for advisors is what can I do about my main residence? And it’s a difficult one.’
‘Often people will say, ‘Well, can I gift it to my son, but I carry on living in it?’ and you can’t do that. There are rules, gifts with reservation of benefits. You can gift it to your son, but if you carry on living there, you’ve reserved the benefit, so it’s going to remain inside your estate.’
‘Taking it a step further, it creates all sorts of other problems because whilst it remains in your estate for inheritance tax purposes, legally you have actually gifted that property, so we mentioned the seven-year rule earlier on. This is one of those things where you can’t say ‘I gift you my main residence now, but I’m going to carry on living in it for several years’. That just doesn’t work. No, you gift it now. If you’re currently living in it, it doesn’t work. If you gift it now and you don’t carry on living it and it’s an outright gift, after seven years, it’s outside of your estate.’
Because it’s your main residence. There shouldn’t be any capital gains tax on it, there’s no stamp duty on it. But it’s a difficult one because it’s very rare that someone wants to actually absolutely gift their main residence to one of their children.
‘There are other things that you can look at like co-ownership. That enables you to carry on living in it so you can give 50% of your property to your daughter. You can carry on living in it. But it basically has to become her house as well and then you’re going to be living with your daughter.’
What of your buy-to-let portfolio though? Are the rules around planning for that so fraught with pitfalls?
‘We’ve now got the challenge that we talked about when we we’re talking about incorporation in a previous discussion. That transfer is a taxable event for capital gains tax purposes. So, if you’re not receiving any consideration for that, you’ve got a dry tax charge that you’ve got to pay within 28 days,’ explained Richard.
‘If that child is under the age of 18, the income that they receive is going to remain taxable on you, so transfers outright are difficult, and you’ve also got to accept that you cannot retain any interest in the income from that property. It’s relatively unusual.’
Trusting in trusts
There is a lot of talk around trusts as an option. Is this something that is worth considering?
‘It’s a common question that advisors get asked. Trusts are not the kind of magic bullet. There’s been a lot of changes in the last 15 to 20 years around trusts and the benefits are probably fairly limited,’ explained Richard.
You have potentially similar issues around capital gains tax, although if it’s a discretionary trust, there is an opportunity to hold over that gain. So effectively the trust takes on that property, but at its original base costs, so it will suffer the full gain on a future disposal.
‘You’ve got issues around the transfer, or cannot benefit from the income – if they can’t benefit from the income and that asset will remain part of their estate even though they’re gifted into trust. So it’s you know, it’s not often the right solution.’
So, what should landlords be doing right now?
‘Plan for it!’ stressed Richard. ‘You can be a lot more organised about it. ‘The longer in advance you do it, the more benefit there will be.’
Protecting your assets
Once you have a plan in place for how you are going to pass on your portfolio, you should also pay close attention to how you are going to keep it safe whilst it is under your care.
We caught up with Mashroom’s very own Emi Steadman, who talked us through some of the things that a landlord should be looking to cover, as well as what might happen insurance-wise in the event of their death.
‘I think the three main things that are really going to hit landlords in the pocket are:
- Rising eviction costs
- Rent arrears
- Home emergencies
If your boiler breaks down, do you have a grand lying around to get that fixed? Do you have £20,000 to hand if you need to evict a tenant? And what you’re going to do if your tenants do fall into rent arrears?’ asked Emi.
‘I think that they are questions that you need to ask yourself, and then make sure that you invest in the right protections and invest in the right insurances. You do it at the start of the tenancy and you know that you’re protected throughout income throughout.’
What landlord insurances are compulsory?
So many costs for landlords are compulsory, are any of the insurances you’ve mentioned a legal requirement, or are they just really useful to have?
‘It’s not like buildings insurance, which you have to have for your buy-to-let mortgage. It’s just something that I would strongly recommend that you invest in’, explained Emi. ‘I think whether you’ve got just one property, or you’ve got hundreds of properties, your properties are your investment, and you need to look after and protect your investments.
‘We have our Let and Protect packages, at 2% and 5%. That includes guaranteed rent with Rent Guarantee Insurance, covers your home emergencies with home emergency insurance.’
‘I think also what’s really good about our Home Emergency Insurance is it’s a policy that’s held by both the landlord and the tenant. So, let’s just say there was a burst pipe at 3am, your tenants can call that policy without the landlord having to lift a finger and the landlord’s got the cover there and it’s already sorted out. And then of course, third thing we’ve got £25,000 of legal cover as well.’
‘We just bought out our rent takeover, which is something we’re doing a lot more of now. If you’re already in a tenancy, you don’t need to find new tenants. You’ve already got it all sorted. You can literally just transfer over to Mashroom just with a few clicks. It’s really simple.’
Passing on your planning
So, insurance is clearly a useful tool to have, but does it have any bearing on inheritance tax or how you need to structure your planning?
We discussed the issue with Sunny Chana, one of Mashroom’s buildings insurance specialists to find out how your insurance is impacted when the worst happens.
This differs from insurer to insurer,’ explains Sunny. ‘Some insurers allow you to carry on the policy to the end. But some insurers will say ‘Yes, we need to decline the policy and start a fresh one’’.
‘We will wait for the solicitor’s executives to contact us and we will give them the leeway until all the information is provided. We will change then only, and we will give them a period of time to get things sorted. Because obviously, it’s a difficult time for everybody involved.
Is there anything executors have to do in order to make sure that insurances stay legal and correct?
It is vital for executors to contact us, because if any claim arises and we found out that the actual landlord has passed away, it will create an issue. So it is very important for executives to contact us and inform us regarding the situation. We have to put their name on the insurance policy, and the policy will be changed from the name of the landlord from executives of the deceased person and the additional insured person will be added on.
Is it the same for a residential property?
‘Same thing again,’ said Sunny. ‘It depends if the property was jointly owned, or if it’s solely owned. If it’s solely owned, definitely the executor or the solicitor will come into the picture. And they have to inform the insurance company. But if it’s jointly owned, then automatically the second policyholder will become the owner of the property rights.
What would happen if you inherit a property that was previously rented, and there is a tenant in situ – do current insurances just carry over?
‘It depends on the insurer whether they allow the policy to continue. Some insurance will say we need to terminate the policy, some insurance will allow you – the insurance we have at Mashroom allows us to continue.’
The next episode of the Mashroom Show is airing on the 5th May, and we’ll be joined again by Richard Cunningham. He’ll be talking about the very real risks involved in the Rent to Rent scheme – something that is growing in popularity, so well worth getting to grips with.
In the meantime, why not head on over to Facebook and join the Mashroom Landlord Community Facebook page. There are over 6,000 landlords regularly chatting, sharing queries and questions and engaging with industry experts, so it’s a great place to have a chat about what’s on your mind, and get some great advice.