When your loved ones are seriously ill understandably the last thing you want to think about is anything to do with finances. However it is worthwhile knowing that in cases where a spouse or civil partner is terminally ill there could be an opportunity to save large amounts of tax by passing property in a tax efficient manner.
Property Owners Tax Planning
When property passes between spouses or civil partners it is done on a nil gain / nil loss basis. That means there is no capital gains tax (CGT) payable. Also such transfers are exempt from inheritance tax (IHT).
So if investment property owned either outright or jointly is transferred as a lifetime gift to the unwell spouse or civil partner there would be no tax to pay.
Then when the unwell spouse sadly passes away, assuming that the individual’s Will states that their estate is left to the surviving spouse or civil partner, the assets will be transferred at market value. Again no tax is payable because spousal transfers are exempt from IHT and there is no CGT payable on death.
If the couple were sitting on significant gains because they owned the properties for a long period, or because prices in that area have increased substantially, then the surviving spouse or partner will now benefit from a free uplift in the form of an increased base cost of the property to current market value. That means when they come to sell those properties their CGT liability will decrease significantly. In fact if they sold shortly after their partner’s death there would most likely be no tax to pay at all.
Alternatively, the surviving spouse could look to transfer the portfolio soon after to loved ones, or even a family limited company or trust without any capital gains tax liability.
For IHT purposes such a gift to an individual would be a potentially exempt transfer and provided the transferor lives a further seven years then this will also fall outside of their estate for IHT purposes. Gifts to trusts or companies are treated as chargeable lifetime transfers. That means gifts up to £325,000 will usually be exempt but any amounts above that will be taxable at 20%. After seven years they also fall outside the estate, meaning the £325,000 nil rate band is reinstated on death.
This is a complicated area of taxation but there are potentially huge tax savings if you take the right advice. There are also some pitfalls that need to be addressed before taking any action:
- If there are mortgages outstanding on any property transfers there may be a stamp duty land tax liability.
- You need to check the mortgages are not fixed and consider early settlement fees.
- If the unwell spouse needs social care putting more assets in their name could reduce their entitlement to council assistance.
Unmarried Couples Tax Planning
For those who have been together for a long time but never married there is a clear advantage to tying the knot if you want to take advantage of the tax planning detailed above. Even if you are not property investors if the estate of the unwell partner would suffer inheritance tax there is a clear advantage to marriage where assets would go completely tax free to the spouse. Bear in mind that estates of more than £325,000 could pay inheritance tax, which given the increase in property prices over the last few years would affect many more people than you might expect.
Using Your Annual Exemption
Where there is no spouse or civil partner to leave assets to, and the estate will pay tax, you can reduce that tax liability by making lifetime gifts. You can give away £3,000 tax free per year and carry forward any unused amount for one year. That gives a maximum of £6,000 at 40% – so £2,400 saved. Not a fortune – but every little helps.
Investing in ‘Business Assets’
Unfortunately it’s not always possible to take advantage of the seven year waiting period before lifetime gifts fall outside your estate. However if your estate includes ‘business assets’ these only need to have been owned for two years to be completely exempt from IHT.
Business assets for these purposes include AIM listed shares or shares qualifying for Enterprise Investment Scheme relief. You can even invest in Business Property Relief ISAs, which if held for two years can be passed on to any beneficiary completely free from IHT.
Preserving the Residence Nil Rate Band
We’ve mentioned the residence nil rate band in several previous blogs because it is a very important tax saving tool which should not be overlooked when undertaking estate tax planning. It provides an additional nil rate band of up to £175,000 per person, worth £70,000 in tax or £140,000 per couple.
You qualify for this additional nil rate band if you own your home at your date of death (or downsized on or after 8 July 2015), it is passed to your direct descendants (including step children, foster children and adopted children but not nieces and nephews) and your estate is less than £2 million (there is a form of taper for estates between £2m and £2.65m).
Lifetime gifts do not count towards the estate for the purposes of working out if the estate is valued at more than £2 million. Therefore to use an extreme example:
Jim is 93 and has received the sad news that he is terminally ill and is unlikely to live for more than a couple of months. His estate is worth £3 million, made up of his main home worth £1 million, four rental properties worth £250,000 each and £1 million in various bank accounts. All of his estate is being left to his two children and he has made no lifetime gifts to date. His late wife died ten years ago leaving her whole estate to Jim.
As it stands when Jim passes away his estate will benefit from his own nil rate band plus that of his wife:
Estate value 3,000,000
Less nil rate bands ( 650,000)
Taxable estate 2,350,000
IHT Payable £ 940,000
However if Jim were to transfer his entire savings to his children before he dies his estate is reduced to £2million. He therefore has two nil rate bands plus two residence nil rate bands worth £1,000,000. His tax bill becomes:
Failed potentially exempt transfer (died within 7 years of gift) 1,000,000
Less gift relief (unused from current and previous tax year) ( 6,000)
IHT Payable at 40% 376,000
Estate on death 2,000,000
Less nil rate bands (1,000,000)
Taxable Estate 1,000,000
IHT Payable at 40% 400,000
Total IHT Liability 776,000
Total Tax Saving £164,000
You will see that there are potentially substantial tax savings to be had and most people on their death bed would rather more money went to their family than the tax man! The above is just a sample of the many ways inheritance tax can be saved. The key however is to take professional advice and action that advice as soon as possible, and not necessarily wait until just before you die! If you would like help with inheritance tax or capital gains tax planning contact Darren or Jan in our tax team.
The content in this blog is correct as at 15 October 2021 See terms and conditions.