Trusts are extensively used to preserve and protect the family’s assets by ensuring the assets pass to the correct people when they have the necessary maturity to inherit.  With the tax benefits they also provide Trusts are also a valuable solution for clients who want to plan using investment properties/second homes.

With income tax rates remaining high the Government is focused on Inheritance Tax (IHT) to increase the tax take.  Inheritance Tax is a voluntary tax which depends on your resolve to avoid it rather than your inability to do so.

The nil-rate band, which is currently £325,000, has been frozen since 2009 whilst asset prices have increased greatly. More and more individuals are quietly falling into the net.

Many families’ assets consist of the accumulation of real estate through a number of investment properties.  Property prices have increased considerably over the last 20 years and continue to do so.  This is becoming a major tax issue on death.

The use of trusts continues to be an excellent planning tool for both IHT, capital gains tax (CGT) and income tax planning.  They are also extensively used to preserve and protect the family’s assets by ensuring the assets pass to the correct people when they have the necessary maturity to inherit.  Trusts provide a valuable solution for clients who want to plan using investment properties/second homes.

Property Trust Case Study

Mike and Molly are married, both are 59 years old and worth £2m combined.  Their wealth is comprised of a family home (£750k), two investment properties (£250k each), cash (300k), and other investments (450k).  Their combined annual income is £200,000 (Mike £160k and Molly £40k).  They have a child (Ed), age 30, and a grandchild (Raj), aged 2.

Issues for M&M:

  • They currently have a high income level and as a result pay between 40%-45% on all rental income received from their investment properties
  • M&M each have an estate in excess of £325,000 (nil rate band) and therefore will pay 40% on the balance of his estate above this level
  • They purchased the properties in 1992 when they were each valued at £50,000 therefore each property benefiting from a capital gain of £200,000.

Objectives of M&M:

  • Concerned about IHT
  • Concerned about the significant capital gains in the property
  • They do not need the income from these properties anymore
  • No need for future capital from these properties
  • Concerned over relinquishing complete control of their assets

Focusing on the investment properties

Options available to M&M:

  1. Do nothing

If the clients undertake no planning the position is as follows:

Advantages
  • No CGT payable on death
  • Retention of income
  • Retention of control
Disadvantages
  • IHT would be payable at 40% – £200,000
  • Income on rental income taxed at higher rates

  1. They could gift each property absolutely to Ed and or Raj.Gifts of each investment property

Advantages

  • Full IHT savings after 7 years – £200,000
  • No stamp duty land tax (no mortgage)
  • Income taxed on Ed and/or Raj – potentially less income tax payable
Disadvantages
  • Loss of control
  • Disposal for capital gains tax
  • Increase in estates of Ed and Raj leading to potential IHT burdens for them in future.
  • Loss of income
  • No protection for the assets

  1. Transfer of each investment property into a Company

Advantages
  • Potential future income tax and capital gains tax benefits
  • A structure they can use to build a property portfolio
  • Retention of income and capital
  • Retention of control
  • Limited liability
Disadvantages
  • Loss of control
  • Disposal for capital gains tax
  • Stamp duty land tax implications

  1. Mike and Molly would create a single/two trusts and transfer the properties into itTransfer of each investment property into Trust

Advantages
  • Full IHT savings after 7 years – £200,000
  • No stamp duty land tax (no mortgage)
  • Income taxed on the beneficiaries – potentially less income tax payable
  • Ability to defer the payment of CGT
  • An on-going IHT friendly structure
  • Retention of control/Protection/Flexibility
  • Protection for the assets
Disadvantages
  • Loss of income
  • Loss of capital

Our Recommended Trust Option:

The Trust option (4) best suits the clients’ objectives.  This is based on the following reasons:

  • The clients want to plan for IHT and this is not provided for via option 1 and the use of a company (option 3) – IHT saving of £200,000
  • The clients are concerned about the amount of CGT payable and only the Trust allows them the opportunity of holding-over the capital gain and deferring the payment of CGT
  • They do not need the rental income. By using a Trust they can shift the income onto their grandchild Raj who has no other income and therefore has his individual income tax allowance fully available.  He is likely to go to nursery and private school at a young age and this will assist with funding it in a very income tax efficient way (example below).  There if the flexibility to take care of further grandchildren born.
  • *The clients can retain some sort of control in the form of stating the parameters of the trust deed as to the powers the trustees have and which beneficiary(s) can benefit and when. They can act as a Trustee
  • The trust provides the clients with a protective structure ensuring the safeguarding of their assets for generations to come

The above illustration shows that Trusts continue to be an excellent planning tool for both IHT, capital gains tax (CGT) and income tax planning.  They also continue to be one of the best structures to preserve and protect the family’s assets by ensuring the assets pass to the correct people when they have the necessary maturity to inherit.

By Raj Kataria TEP