For most people, their properties are their most valuable asset. And for anyone with children, the consequence of not having made provision for estate planning may be devastating. Passing on rental property to loved ones, however, can be a complicated process filled with many potential pitfalls. But by taking appropriate steps to mitigate your inheritance tax (IHT) bill as well as avoiding capital gains tax (CGT), you can optimise the value of your property and protect the future income for your family.

Usually, if you want to transfer a buy to let (BTL) property to your children, CGT liability would apply because HMRC states that the parent received the market value of the property – even if the property was handed down for free. That CGT will be based on current market value, minus purchase price, minus capitalised refurbishment costs.

Currently, the rate of capital gains tax to be paid on BTL properties – after using the £11,700 CGT annual allowance – is 18% for basic rate taxpayers and 28% for higher rate taxpayers.  

Can I transfer property into a trust?

While trusts are generally viewed as the exclusive domain of the well-heeled, ordinary homeowners could also benefit from placing their property into a trust. An individual might wish to gift a buy-to-let property to their child and use a trust to manage the asset until the beneficiary comes of age. The benefit of this action will depend on certain conditions that the settlor specifies, while the settlor may themselves also benefit from the trust.

Reasons for transferring BTL properties into a trust may vary, but usually it’s to reduce income tax for the parent, to reduce the asset value of the parent for IHT purposes, and to provide an income for the adult child. HMRC calculates and imposes tax depending on the status and terms of the trust, so it’s important to weigh up all the factors carefully.

Tax relief is possible by leveraging Section 260 of the TCGA legislation. However, to get the most out of it, wait at least three months before you transfer an asset within a trust to your child. This timing ensures that CGT holdover relief is obtainable.

Bear in mind though that – for any avoidance strategy to work – all mortgages for the property must be settled in full and should remain unencumbered upon transfer. This is mainly because mortgage companies are highly unlikely to support this form of tax avoidance. Such a strategy is also only possible when the asset is transferred to an adult child, and not one that is underage.

Exit charges are another factor to consider when transferring the asset from the trust. This is another form of tax on top of the standard 20%. It’s worth bearing in mind that the value of the asset is the net asset value of the property.

Four steps to an avoidance strategy

To take advantage of a trust as a tax relief vehicle, let’s recap the four steps to follow:

Identify a property that has a value below the IHT threshold. i.e. less than £325,000. You can use a property with a higher value, but it will be subject to 20% IHT.

Transfer the property into a trust and determine the IHT liability.

Wait a minimum of three months after setting up the trust then transfer the property to an adult child. Calculate the exit charge.

Complete the IHT100 form and submit it within 12 months of the transfer.

Taking everything into account, avoiding CGT and IHT is entirely possible when transferring a BTL property to an adult child. HMRC can even tell you how to set up a trust. Bear in mind though, that tax calculations can get extremely complex, and we therefore strongly suggest you consult a property tax specialist or finance planner from the outset.

Simon Misiewicz is a property tax specialist at Optimise Accountants.