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Inheritance Tax and Buy-To-Let Properties: Navigating The Complexities

Inheritance Tax and Buy-To-Let Properties: Navigating The Complexities

Wednesday 11 October, 2023

The world of buy-to-let properties has long been an attractive avenue for investors seeking to diversify their portfolios, leverage rental income, and grow long-term capital appreciation. However, with every lucrative investment comes tax considerations that often surprise the uninformed. One of these surprises revolves around Inheritance Tax (IHT).

If you own buy-to-let properties, it is crucial to be aware of potential IHT implications. This article offers an overview of these issues, and the strategies you can employ to navigate them, ensuring that your heirs benefit the most from your investments.

Buy-To-Let Properties in St Albans

St Albans is a commuter's paradise and a property investor's dream, all rolled into one. And, in the last 10 years St Albans has seen a huge influx of buy-to-let property development. As local accountants in St Albans, we have seen a steady increase of enquiries relating to Inheritance Tax and Buy-To-Let Properties.

Inheritance Tax Issues and Buy-To-Let Properties

1. Understanding the Basics

Inheritance Tax is a tax on the estate (property, money, and possessions) of someone who's died. The IHT threshold stands at £325,000 for an individual and remains frozen at this level. This means, if your estate is valued over this threshold, a 40% tax rate could be applied to the excess when you pass away.

For many, their primary residence will take up a significant chunk of this allowance, but buy-to-let properties can quickly tip the scales. Unlike your primary residence (which may qualify for an additional nil-rate band if passed to direct descendants), buy-to-let properties are fully exposed to IHT.

2. Business Property Relief – An Exception?

There's a common misconception that buy-to-let properties qualify for Business Property Relief (BPR). While BPR provides relief from IHT on certain business assets, most buy-to-let properties do not qualify. However, if your property activities are more akin to a hotel or B&B, or if you offer significant services beyond just renting space, there's a possibility for relief. Each situation is unique, and professional advice is key.

3. Gift the Property and Survive Seven Years

One method of reducing IHT exposure is gifting the property. If you gift a property and live for another seven years, the property will be out of your estate for IHT purposes. However, keep in mind:

  • You must not retain any benefits from the property, i.e., you can't continue to collect rent.
  • If you die within the seven-year window, a tapered IHT charge may apply, reducing annually until the seven years are up.

4. Consider a Trust

Placing the buy-to-let property in trust might be another avenue. This action can remove it from your estate. However, the rules and regulations surrounding trusts are intricate. Setting up and managing a trust can be costly, and there are other tax implications to consider, so weigh the benefits and costs carefully.

5. Joint Ownership

If you own a buy-to-let property jointly, it's worth checking how ownership is structured. If it's 'tenants in common', your share of the property will pass according to your will. If it's 'joint tenants', your share will automatically pass to the other owner(s), potentially reducing IHT liability.

6. Splitting Ownership: Capital and Income (FA 1986 s102B (2))

One of the lesser-known provisions, yet immensely beneficial in specific circumstances, is the ability to split the ownership of a buy-to-let property between capital and income under the Finance Act 1986 s102B(2). This mechanism allows one person (or party) to own the capital value of the property, while another receives the rental income.

For example, parents might retain the capital ownership, ensuring the property's value will form part of their estate, while their children might own the income rights, directly benefiting from the rental income. This not only provides an income source for the younger generation but can also serve as an IHT planning tool since the rental income doesn't accumulate in the parents’ estate. Alternatively, if the parents are dependant on the income, they may gift 99% of the capital value and retain the income rights. After 7 years 99% of the capital value is then outside their estate.

However, splitting ownership comes with its intricacies:

  • Stamp Duty Land Tax (SDLT): Transferring income rights might be considered a land transaction, possibly triggering SDLT. It’s crucial to understand potential tax implications before making decisions.

  • Capital Gains Tax (CGT): Splitting ownership could also trigger a CGT charge, based on the market value of the income right, as it's treated as a part-disposal of the property.

  • Income Tax Implications: With the rental income directly going to the children or another party, they become responsible for any income tax due. Depending on their tax band, this could be beneficial, but it's crucial to evaluate and plan accordingly.

7. Reduce Value through Lease Extensions

Another strategy to consider, specifically for properties with diminishing leases, is extending those leases. A short lease diminishes property value. By gifting a property with a shorter lease and then financing its extension, the original value (when gifted) remains lower, thus potentially reducing the IHT implication.

8. Making Use of Annual Exemptions

While the spotlight is often on larger exemptions and reliefs, don’t forget the smaller, annual ones. Each individual has an annual gift allowance of £3,000 which won’t be added back into the estate value for IHT purposes, even if the donor doesn't survive seven years. Over time, and especially when combined with other strategies, this can significantly reduce an estate’s IHT exposure.

9. Take Out a Life Insurance Policy

A life insurance policy can be an efficient way to provide funds to cover the IHT bill. If the policy is written in trust, the proceeds can be outside your estate and can be used by beneficiaries to pay the tax.

10. Borrow Against the Property

Debt is deducted from the value of your estate before IHT is calculated. By re-mortgaging a buy-to-let property, you can reduce its net value in your estate. However, this strategy requires careful planning. The borrowed funds should ideally be spent or given away to ensure the debt genuinely reduces the estate's value.

11. Seek Professional Advice

Each investor's circumstances are unique. Therefore, navigating the intricate web of tax laws requires tailored strategies. Working with experienced accountants and tax planners ensures you maximise reliefs, minimise liabilities, and leave a lasting legacy without unwanted tax surprises.

Conclusion: Navigating with Precision and Expertise

Chris Wallace, Managing Director and Accountant in St Albans said:

“The realm of buy-to-let properties is both rewarding and complex. While they offer solid financial gains, it’s essential to navigate the potential IHT implications adeptly. By understanding and leveraging provisions like the Finance Act 1986 s102B(2) and combining it with other strategies, you can ensure a more optimised inheritance plan for your loved ones.”

Yet, every individual's situation and goals are unique. Tailored advice, built on a deep understanding of the ever-evolving tax landscape, is essential.”

Our dedicated team at Visionary Accountants is committed to assisting you in this journey, ensuring your buy-to-let investments are structured efficiently for the present and the future. Contact us today for a comprehensive IHT planning consultation.

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