Mr and Mrs A are 65 years old and have a home worth around £1m as well as substantial pensions which are sufficient to live comfortably on. Ten years ago Mr A inherited his parents flat which at the time was worth about £300,000. He refurbished it and rents it out, generating an additional income of about £20,000 a year, most of which he gives to his children and young grandchildren. The flat is now worth £500,000.
Their home is covered by their inheritance tax (IHT) allowances, but without any planning their family would suffer an additional £200,000 in IHT on the value of the flat. In addition, Mr A is a higher rate taxpayer and pays 40% tax on the rental income, before giving the remainder away to his children. However, there is also a capital gain on the property of around £180,000 which would cost nearly £50,000 in capital gains tax (CGT) if he were to gift the property to his children now.
After discussing his options surrounding the property, it was decided that it would be prudent for Mr and Mrs A to establish a family trust to benefit their children and grandchildren now and in the future. Mr and Mrs A gifted the flat into trust.
Mr and Mrs B are 70 years old and have a home worth £1m. They have no significant pension provision, however, they do own a commercial property which they used for their business before they retired, but which is now let out to a number of tenants. The commercial unit is worth around £800,000 and generates annual income of around £60,000. Mr and Mrs B rely on the rental income to support their lifestyle, although they know, as they get older, they may not need as much income.
We discussed the possibility of restricting the ownership of the commercial unit and establishing a formal partnership between Mr and Mrs B to manage the unit. Mr and Mrs B also established a family trust and transferred a 75% share of the capital rights in the partnership into the trust. This meant that the partnership was formed of Mr and Mrs B and their family trust. Each year the partners decided how to allocate the profit of the partnership with most of the income being distributed to Mr and Mrs B. However, 5 years later their children took over management of the properties and took on the role of Trustees, effectively becoming partners in the partnership. As they were now involved in the management of the properties the partners agreed that a larger share of the partnership profits should be paid into the trust, which then allowed it to contribute towards the university costs for Mr and Mrs B’s grandchildren at a negligible tax cost. After 7 years the commercial property was valued at £1m
Mr and Mrs C are 60 years old and have a home worth £1.2m. They have worked for the past 20 years to build their property portfolio which now includes 10 residential investemtn properties worth around £3m. Over the years they have focused on reducing their mortgages. The outstanding values now are around £500,000, giving them equity in the portfolio of around £2.5m. Most of the properties (around £2 million)are in Mr C’s name as historically it was easier for him to get mortgages as he was the higher earner although a couple (£500,000) are in Mrs C’s name.
Mr C’s total estate including his share in the family home is worth around £2.6m, his Residence Nil Rate Band of £175,000 will be tapered to zero. Although Mrs C’s estate is only £1.1m, if Mr C dies first and leaves everything to Mrs C then her estate will also exceed the taper threshold of £2m and she will not be entitled to the Residence Nil Rate Band either. Due to this, their inheritance tax allowances are limited to £650,000. With a combined net estate of £3.7m and allowances of only £650,000, this leaves them with an inheritance tax exposure of over £1.2m.
We advised Mr and Mrs C to redraft their Wills which protected Mrs C’s Residence Nil Rate Band in the event of her dying first and by equalising their estates it was possible to reduce Mr C’s estate to below £2m thus safeguarding his Residence Nil Rate Band if he died first. Either of these processes would save them IHT on £175,000, which is worth £70,000 in tax and would be effective immediately.
We discussed the use of the family trust structure mentioned above, which when combined with the Will planning mentioned above could save the family over £330,000 in inheritance tax. However, this would still leave them with a tax bill of over £850,000 on their death.
Consequently we advised the family to establish a Family Partnership structure to hold the value in the properties going forward. This was a more complex structure that allows their children to be actively involved in the ownership, income, and management of the property portfolio. When combined with a family trust structure the Family Partnership allowed Mr and Mrs C to pass a significant amount of the value of their portfolio to their children over the course of 7 years without triggering any tax. Future growth was ringfenced in a family trust and the inheritance tax saving started to accrue after 3 years. After 4 years their exposure to inheritance tax was reduced by over £300,000 and after 7 years the saving was more than £1.1m.
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