Property and UK Tax Part 7
This week we’re going to think about “death” as our exit strategy as well as the implications of this from a tax perspective. I want to combine two statements which I often hear people say. The first is “death is my exit” and the second is “I want to pay down my mortgages so all of my properties are unencumbered and I can leave them to my children”.
Let’s look at the first statement. When I hear “death is my exit”, I presume that an investor is planning to hold their properties forever. When they die, they will still own their properties. Presumably, the property business which is probably going to be set up as a limited company – or as shares within a limited company – will be passed over to the children, spouse or significant other.
Now let’s look at the second statement. Many people often say that what they really want to do is to pay down all of the mortgages so that the properties are free of debt when they leave them to the children.
When I hear this statement, I question if the investor has given real any thought to whom they are actually leaving the properties to. The reality is that if they pay down all of the mortgages and leave the properties unencumbered, then it’s probably going to benefit HMRC more than the children.
Inheritance tax kicks in at the point of death, and depending on how you have structured your entity, your children or wife etc. could potentially end up paying out part of the value of the unencumbered properties.
This could be quite a substantial figure because as it stands today, inheritance tax is charged at 40%.
So, the argument around should we pay off our mortgages or not is an interesting one, and you can see why it’s so important to structure your business correctly from the outset. (Not only to be as tax efficient as possible, but to hopefully mitigate inheritance tax as well).
What you could do is remortgage your properties when they go up in value, and then take the money out and spend it. Whilst the idea of this may sound completely reckless, it actually isn’t. However, this is assuming that you have got to the stage whereby you have such a large portfolio that you don’t need to buy any more properties. You could then live off the passive income, and every time the properties go up in value, you could take a little bit out.
Obviously, as you grow your portfolio you’re going to be building your debt and liability against the assets. You might wonder if this is a good or a bad thing – well, it all depends. What I’m thinking is that if you keep taking money out and building the debt against the assets, then when it comes to inheritance tax, it will only be paid on the difference between the loan and the value of the property. As such, the inheritance tax bill would be reduced.
Let’s consider for the moment something else. If you do structure everything through a limited company and if you pay down your mortgages in your limited company, there is an upshot with regard to the shares. The value of the shares of the company are going to increase.
Having shares within the shell of the company doesn’t mitigate inheritance tax per se; in fact, if you’re going to pass the shares onto your family at death, you’ve created an inheritance tax liability.
If you really want to pass things over to your children, a way around this might be to bring them in as shareholders at the very beginning when you set up the limited company. Talk to your accountant and your solicitor as they may be able to shed some light on this.
However, while this all sounds well and good, there are going to be downsides as well as upsides. Although lenders are becoming more open to lending to limited companies, one of the things which they may question is who are these shareholders. They might also want to look at the financial credibility of the shareholders. As such, if you’re bringing the children into the company, it could affect “lendability”.
It does vary from vary from bank to bank but this is something to consider and to maybe discuss with your mortgage broker. Unfortunately, there’s no simple solution. Then again, nothing is straightforward when it comes to property and UK tax.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, author and property investor
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