How to Avoid Capital Gains Tax and Inheritance Tax on the Transfer of Property to Children

Capital gains tax. Lets look first at the capital gains tax position of a transfer of property. On the assumption that the parent is UK resident and domiciled any transfer of property will be subject to UK capital gains tax. You’ll therefore need to calculate the gain arising and crucially to consider the offset of reliefs to reduce this gain.It’s worth noting that the residence of the child is irrelevant for UK tax purposes. Therefore, even if they are tax resident in a tax haven, the UK resident and domiciled parent will still have to consider their own capital gains tax position.As parents are classed as ‘connected’ with their children for capital gains tax purposes, any transfer from the parents to the child is treated as a market value transfer. As such, even though the children don’t pay any proceeds to the parent for the property when calculating the capital gain it is the market value of the property that needs to be considered.The gain will therefore represent the uplift in value from the date of acquisition or probate value to the market value at the date of transfer. Note if the property was acquired before March 1982 there are special provisions that can apply to deem the cost to be the market value at March 1982.What reliefs are offset?It is the reliefs that can significantly reduce any capital gain. The main reliefs that any parent would be looking to consider to reduce the capital gain would be:
Indexation relief if the property was acquired before April 1998. This adjusts the cost (or probate value) for the effects of inflation up until April 1998
Taper relief. You’ll need to consider what type of property it is. If you’re looking at transferring a residential property it will nearly always be a non business asset. This will reduce the capital gain by up to 40% if you’ve owned it for at least ten years. Ownership of less than this will qualify for a reduced rate of taper relief (eg ownership of 5 years will qualify for taper relief of 15%) dependent on the period of ownership above three years. So three years ownership qualifies for 5% relief, four years for 10% etc.If however the property is either a Furnished holiday let or is used for the purposes of a trade (eg it is a shop, office or factory that is transferred and it has been used by a trader) it will qualify for at least some business asset taper relief. This can be very beneficial as maximum business asset taper relief can reduce the gain by 75%. So if you’re looking at transferring a business asset the gain is likely to be significantly reduced.

Gift relief. If a property is used for the purposes of the parents trade or their trading company they may be able to claim gift relief. This allows a deferral of the gain arising (provided the child agrees!) and allows the parent to pass the property to the child free of capital gains tax. The future disposal of the property by the child would then crystallise the deferred capital gain.
Annual exemption. If the parents own the property jointly the humble annual capital gains tax exemption should not be forgotten. It allows each individual to exempt (currently) £9,200 of any gains from capital gains tax in each tax year. So if the parents had no other capital gains, the annual exemption could ensure that a gain of around £18,400 was fully exempt from tax.
Other capital gains tax exemptions such as rollover relief and the EIS deferral relief would not apply as there are no disposal proceeds!Non UK resident parentsIf the parents are non UK resident and non UK ordinarily resident they can transfer UK property to their children free of CGT subject to two caveats.
Firstly this doesn’t apply to any property that is used for the purposes of a UK trade. Therefore if you run a UK business and use the property for that business you can’t claim the CGT exemption even if you’re non UK resident.
Secondly if you own the property at the date you leave the UK you’ll need to ensure that you remain non UK resident for at least five complete tax years to avoid UK capital gains tax. If you come back before the expiry of five tax years the capital gain will be charged in the tax year of your return.
Non UK domiciled parentsIf the parents are UK resident but non UK domiciled they can transfer overseas property to their children free of capital gains tax. This applies irrespective of the residence and domicile status of the children. If the property was UK property this exemption would not be available and the capital gain would simply be charged as usual. Form of transferIt’s important to note that the transfer needs to be of the beneficial interest in the property. This does not necessarily tie in with the legal interest.This means that if you wanted to transfer the property to your children you could transfer just the beneficial interest and retain the legal interest, or transfer the legal and beneficial interest together. If you transferred just the legal interest and retained the beneficial interest there would be no effective transfer for Capital Gains purposes and you’d still be treated as the owner of the property in law.It can sometimes be easier to just draft a deed of gift and arrange for the beneficial interest to be transferred.Inheritance taxAny transfer at undervalue from the parents to the children will usually be a potentially exempt transfer (‘PET’) for inheritance tax purposes. Again I’m assuming initially that the parents are UK resident and domiciled.So in the case of a gift of the property the full market value of the property will be treated as a PET. If the children were to pay some of the value to the parents it would only be the difference between the market value and the amount paid that would be a PET.With a PET there is no immediate Inheritance tax charge on the parents and provided they survive for at least seven years from the date of the transfer the amount gifted would be excluded from their estates for inheritance tax purposes.Note that the residence and domicile status of the children is again irrelevant.Non Resident parentsNon UK resident parents would have no impact on the Inheritance tax position, and the transfer would still be a PET for inheritance tax purposes.Non Domiciled parentsIf the parents are non UK domiciled they can transfer overseas property to their children free of any Inheritance tax implications — irrespective of whether they survive for seven years or not. UK property is unaffected (unless it’s owned via an offshore company) and non UK domiciled parents would still be classed as making a PET on the transfer of UK property to their children.Gift with reservation of benefit rulesIf the parents make a gift to the children and retain a benefit in the property transferred there are special anti avoidance rules than can ensure that the property is not classed as a PET for Inheritance tax purposes.Instead the property remains within their estate for Inheritance tax purposes until the benefit ceases. This could apply for instance if the parents continue to live in the property, of if they continue to benefit from the rental income obtained from the property. One way that they could get around having the property still in their estate would be to pay the children a market rate for the benefit that they get from the property (eg market rental).Stamp duty Land TaxUnless the property is mortgaged the parents should be able to transfer the property to the children free of stamp duty providing it is a genuine gift. If there was any proceeds payable to the parents this would then be classed as ‘chargeable consideration’ for stamp duty purposes and a stamp duty charge would need to be calculated.Note that if there is a mortgage or any other form of debt that is transferred from parents to the children with the property this would also be classed as ‘consideration’ for the purposes of stamp duty.

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