Lee Sharpe looks at some of the tax issues arising from transferring property to the next generation.
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This is the first of several articles that will cover key tax aspects of transferring property to the next generation during one’s lifetime. It is assumed that all parties are long-term tax-resident in the UK (and nowhere else).
It is worth pointing out that, as confirmed in Spring Budget 2023, the capital gains tax (CGT) regime for divorcing couples, etc. is undergoing wide (and welcome) reform, which is beyond the scope of this article.
A good idea?
Rumour has it that successful property investors risk being ‘too successful’ in that, over time, their personal portfolios will increase in value while the corresponding mortgages are paid off, ultimately leaving them with good personal incomes but substantial (and growing) personal capital wealth.
Eventually, inheritance tax (IHT) will be a pressing concern for many. Unlike with most qualifying activities (i.e., most trades and professions), a property letting business will almost certainly not qualify for IHT reliefs, and the landlord/landlady may face losing as much as 40% of the value of their property wealth to IHT.
It follows that moving at least some property wealth to one’s children may avoid the worst of the IHT cost on death. But avoiding IHT on death may mean paying much more tax on such transfers during one’s lifetime.
We shall assume that the landlord/landlady wants to give away some proportion of their lettings portfolio. If you sell a property for full value, you will typically have to pay CGT but your IHT estate will have moved hardly an inch otherwise; valuable bricks and mortar will simply have been replaced by cold, hard cash (albeit potentially net of CGT).
Trap 1: Do I pay capital gains tax on a gift?
Yes, probably. CGT is basically chargeable on the full market value of an asset, and when the original owner gifts any property or deliberately sells it at a discount, tax law demands it be taxed as if sold for full proceeds.
When you transfer to a third party, it is possible to make a ‘bad bargain’ whereby you sell at under-value effectively by accident, in which case you can continue to use the actual proceeds rather than market value. However, when you transfer to a connected party such as close family, there is basically no ‘bad bargain’ and market value must be used in the CGT calculation, irrespective of any consideration actually received.
For ordinary rental properties and disposals, the only meaningful exception to this treatment would be disposals to one’s spouse or civil partner (by gift or otherwise). But aside from transfers between spouses etc. who are living as a couple, the fact that the donor may not actually receive any money for the transfer to their children or similar does not prevent a CGT charge on full value.
Trap 2: Does the 60-day limit apply to property gifts?
Usually. Even a gift is subject to the regime that requires a special notification and payment on account of CGT no later than 60 days after the transfer. This applies only to residential property for UK tax residents and only if there is CGT to pay.
So, again, transfers between spouses or civil partners (or gains wholly exempt under the CGT ‘only or main residence’ regime) would not be caught.
Trap 3: Can I pay CGT on a gift but STILL be exposed to IHT?
Potentially. The two regimes largely work independently of each other. When one person gifts property to their (grand)children or similar, they will likely suffer CGT on any uplift in value during their period of ownership prior to the disposal. It will then be treated as a ‘potentially exempt transfer’ for IHT purposes, meaning that tax law effectively assumes that the gift is IHT-exempt but will change its mind if the donor dies within seven years of the gift.
The value of the gift (or, more accurately, the reduction in the donor’s estate at the time of the gift) is added to the chargeable estate on death, although the IHT charge eventually raised on that item may benefit from taper relief if the donor survives the gift by at least three years – with more relief for extra years between gift and death. There may also be nil rate band to claim (i.e., broadly, a personal allowance of £325,000 for IHT purposes), but the rules for this relief can be quite involved; it is assumed here for simplicity that any available nil rate band will have been used elsewhere.
As with CGT, transfers between spouses and civil partners generally enjoy wide-ranging exemption from IHT (although special rules may apply for spouses etc., who are not UK-domiciled). Aside from spouses etc., there is a special provision to allow the donor in many cases to hold over (i.e., postpone) any CGT due on a gift when both IHT and CGT would be chargeable on the same transfer; but IHT is usually triggered later on, on death (i.e., so scope for this relief is relatively limited, although one exception is where the lifetime gift is to a trust; this can, on occasion, be quite useful).
The ’Murdoch manoeuvre’
I read somewhere recently that media mogul Rupert Murdoch is on the verge of marrying his seventh wife. Mr Murdoch is reportedly even older than Methuselah, while the slightly hazy target of his nonagenarian affections is a mere slip of sixty-something. I accept that sexism is generally frowned upon, but it is an actual and actuarial fact that women tend to outlive men (especially when the man in question has a head-start that pre-dates television and possibly even wireless!).
Assuming Mr Murdoch is actually mortal (and that they are both UK-domiciled for IHT purposes for simplicity), Mr Murdoch’s eventual widow would stand to inherit Mr Murdoch’s estate free of IHT in the UK. Mr Murdoch could gift assets to her during his lifetime or on his eventual death without triggering any CGT or IHT charge.
So, while one might have assumed that moving assets to the next generation meant children or even grandchildren, one should not overlook that even basic tax planning can be useful; Widow Murdoch might comfortably have many years to dispose of the late Mr Murdoch’s assets as received from his estate, gifting assets to children or grandchildren with very little tax to pay.
Example: The curmudgeon’s conundrum
Let’s say Mr Murdoch is 96 and in reasonable health, with Mrs Murdoch a robust 66. Mr Murdoch has largely retired but owns residential investment properties worth £10m, alongside other assets. Mr Murdoch wants to transfer 50% of his portfolio to his wife, who has few assets of her own, so that she can enjoy her own income (and likely reduce their overall annual income tax a little). But there is a potential longer-term tension here.
He can transfer assets now, CGT-free, to Mrs Murdoch. But while the transfer between spouses etc., is ‘no gain, no loss’, the effect is that Mrs Murdoch acquires them at her husband’s old acquisition cost. So if she then gives them away to their children, the CGT on her onward gift might be substantial. However, if Mr Murdoch waits, and leaves them to Mrs Murdoch on his death, she will inherit them both IHT-free and at their CGT value on his death, so she will likely have several years where she can then gift such assets to their children or grandchildren with very modest CGT implications, and a good chance she will outlive the gift by seven years to render her gift IHT-free as well.
Conclusion
It may seem a bit cold, but a significant difference in likely mortalities between spouses and civil partners can be (and often is) exploited to effect very tax-efficient transfers to the next generation – where there is no particular urgency to transfer during one’s lifetime.
