On of the biggest issues of investment property portfolios is inheritance tax. An investment property does not qualify for a Business Property Relief, so is added at market value on death, and Inheritance tax will be payable thereon at full market value less any charges on the investment property such as mortgages.
With the introduction of S24 in 2014 Finance Act , the burden has amplified.
Many professional landlords have incorporated their investment property portfolios to private limited companies. Done correctly, this would mitigate CGT and SDLT on incorporation, i.e. transfer to companies.
However Incorporation means, your shares are revalued on death, and you pay IHT on death.
One way to mitigate this is to form a Family Property Partnership prior to incorporation, making your adult children beneficial partners, then on incorporation, your children will be allocated shares in the same ratio as their beneficial interest in the partnership. By forming a Family Property Partnership, this would dilute your estate automatically without incorporation. Unfortunately, this does not save the partners from higher rate tax, with mortgage interest disallowed as an income tax deduction.
Therefore, incorporation is the route to follow from a Family Partnership, but normal private limited companies will not suffice. What is required is a Family Property Investment Company, preferably with alphabet shares, so each member of family can extract dividends in a tax efficient way to minimise their tax liabilities.
A Family Investment Company will reduce or partly mitigate inheritance tax.
To mitigate inheritance tax, there are two ways:
1. Firstly and most easiest way is to create freezer shares. This entails agreeing a value of shares as at today’s date and having a separate class of shares which will become your growth shares. The growth shares will be exempt from IHT, and the maximum IHT will be payable on your freezer shares. For example, if your current portfolio value was £1m on incorporation, then your A shares or ordinary shares will be valued at £1m. We would create another class, call it B shares, which on creation will have zero value. On death your A shares will be transferred to B shares as per discretionary trust set up. Even if the value of your portfolio is £2million on death, your beneficiaries will only pay IHT on £1 million on probate.
a. The advantage of this is fairly simple to set up
b. Can be very tax efficient
c. Ensures only direct bloodline will benefit
d. The main disadvantage is that IHT is still payable on the current net market value of the shares when set up
2. The second method (which can be expensive) is an exempt trust. This is where a trust is set up and as long as rules and procedures are followed, then the value of the proportion of shares put into the trust will be exempt from any IHT. This is by far the best solution, but the cost of implementation can sometimes be prohibitive. It achieves exactly as per the title of the trust. As it is a trust, it ensures only direct bloodline will benefit from the trust and is very tax efficient.
Please get in touch if you feel you would benefit from a consultation on mitigation of inheritance tax.