When it comes to inheritance tax (IHT), landlords often encounter complicated regulations and uncertain tax burdens.
Recent speculation about potential changes to IHT and capital gains tax (CGT) makes this even more pressing.
Some advisers may suggest strategies that claim to shelter property shares from IHT entirely, but this is rarely achievable.
The truth is that whether properties are held personally, in trust, or within a company, they remain liable to IHT.
With potential tax hikes looming, landlords should be prepared and explore methods to mitigate their exposure.
(Read Time: Approx. 4 minutes)
Topics Discussed:
- Incorporating your property business to reduce IHT liabilities
- Property gifting strategies and partnerships for tax efficiency
Incorporating Your Property Business
If you own multiple properties and operate as a business, incorporating might provide some relief.
Under current rules, Incorporation Relief can protect you from immediate CGT when transferring properties into a company.
The properties will be transferred at their current market value, but it’s essential to note that Stamp Duty Land Tax (SDLT) may still apply.
However, if you transfer six or more properties, you may qualify for commercial SDLT rates, reducing the overall tax burden.
Incorporating offers additional opportunities, such as gifting shares of the company to family members.
While this could trigger CGT, the maximum rate on shares is currently 20%, which is often less than the rate applied to direct property disposals.
Importantly, the value of gifted shares falls outside of your estate for IHT purposes after seven years, potentially providing significant savings.
For those already operating through a partnership, incorporation can proceed without triggering SDLT, adding further tax efficiency to your estate planning.
Gifting Properties: A Potential Strategy
Another option is gifting properties directly to your children or into a trust.
When making outright property gifts, you’ll need to consider CGT on any appreciation in value since the property was acquired.
Additionally, the gain must be reported, and tax settled within 60 days of the gift.
Trusts offer a way to defer CGT. Transfers into trusts are considered Chargeable Lifetime Transfers, subject to IHT on amounts over the current £325,000 threshold (or £650,000 for couples).
However, gains can be held over, allowing the trust to take over the property at its original value, which can then be passed on to your children without an immediate CGT liability.
While these methods provide flexibility, gifting strategies aren’t without pitfalls.
If you continue to benefit from the property (e.g., by living in it), HMRC may still treat it as part of your estate, meaning the expected IHT savings might not materialise.
Family Businesses – Funding School Fees with Dividends
Setting up a family business/trust where the grandchildren are beneficiaries is another option to consider.
By distributing dividends to the grandchildren, you can fund private school fees tax-free, as long as these dividends remain within the grandchild’s annual tax-free personal allowance (£12,570 for the 2024/25 tax year).
It’s essential to structure this correctly to avoid tax traps.
Parents should not gift shares directly to their children, as this could trigger a tax charge.
Instead, grandparents or other relatives can set up the business, ensuring that the dividends fall under the child’s tax allowances.
This approach works well for those looking to manage private school fees in a way that maximises tax efficiency while keeping funds within the family.
Forming a Partnership for Future Growth
For those who want to plan for the long term, forming a family partnership may be a viable strategy.
By allowing family members to participate in future property growth, this approach ensures that most of the estate’s value remains outside of IHT calculations.
It’s crucial to structure these arrangements carefully, ensuring compliance with tax rules to avoid unexpected liabilities.
However, you should avoid using partnerships as a mechanism for eventual incorporation, as the current SDLT anti-avoidance rules prevent this.
Instead, the partnership route is best suited for passing on future property value rather than immediate tax planning solutions.
Using Pension Lump Sums – A Tax-Free Option for Older Parents
If you are 55 or older (rising to 57 from 2028), you can withdraw 25% of your pension as a tax-free lump sum.
This lump sum can be used to cover school fees without incurring any additional tax liabilities.
For parents or grandparents still working, this can be a particularly efficient way to fund education costs, especially if they are higher-rate taxpayers, as the pension withdrawal is tax-free.
Another strategy is to increase your mortgage to cover school fees, and then repay it using the tax-free pension lump sum when you reach 55.
This option allows you to cover education expenses while deferring the tax liability, but it’s essential to consult a financial adviser to ensure it makes sense in your broader financial plan.
Paying School Fees Upfront – Avoiding Tax on Investment Returns
For families with significant capital, paying school fees upfront in a lump sum can offer significant savings.
Many private schools allow you to pay fees in advance, investing the lump sum in low-risk investments.
Since private schools benefit from charitable status, these returns are often tax-free, offering a unique advantage.
If you were to make the same investments personally, the returns could be subject to income tax or capital gains tax, reducing their overall benefit.
By paying fees upfront, not only do you avoid these taxes, but you may also receive a discount from the school, helping to lower the overall cost.
Summary
With careful planning and the right strategies, families can reduce their tax liabilities and ease the financial burden of private education.
Whether it’s through intergenerational gifting, setting up a family business, investing in offshore bonds, or using pension savings, each approach offers opportunities to save on both taxes and school fees.
If you need expert advice on managing private school fees in the most tax-efficient way, contact us at Tax Expert.
Fill out our form here for any questions, give us a call at 01772 788200, or message us on our WhatsApp for out of office hours.
Kind regards,
Ilyas Patel