Should I pass my rental properties to my children?

My husband and I own two rental properties worth £640,000 in total, which we have held for some time and are both standing at a considerable profit. We wish to transfer the properties to our adult children, but we are concerned about the level of our tax exposure on the gift and also that our children would have ultimate control over the properties. Are any tax planning options available to prevent a large tax bill and protect the family assets?

Henry Lowe, a partner at accountants Mercer & Hole, says gifting is often a sensible plan to reduce your future inheritance tax (IHT) bill. The rental returns could also supplement your children’s own income and ensure their tax allowances and lower tax rates are maximised. If you and your husband survive seven years, there is no IHT to pay under UK rules.

Understandably, control is a key concern for many parents, and retaining a small share in the properties will ensure you are involved in any future decisions to sell. 

However, given that the properties are standing at a large profit, transfers to your children will trigger capital gains tax (CGT), irrespective of whether your children pay anything. For example, if you spent £240,000 in total for the properties originally, the gain would be £400,000 (current values of £640,000) and CGT at 28 per cent would be £112,000. In other words, there will be a chunky tax bill and you will need to come up with the cash.

An attractive alternative in your circumstances would be to transfer the properties to a trust with your children as beneficiaries. On transfer, IHT is only payable above the tax-free amount (nil rate band) of £325,000 each.

You and your husband could transfer the full value of the properties — £640,000, plus some cash to cover future expenses — without any IHT. CGT is calculated in the same way as mentioned above, but a key attraction here is a special CGT relief (holdover relief), which can be used to defer the capital gain (£400,000 in our example) until the properties are sold by the trustees. If mortgages are currently in place, you should check whether the bank would permit the transfer, and Stamp Duty Land Tax may be a consideration in England or Northern Ireland. 

Once the properties are owned by the trust, the rental income can be paid to your children as trust distributions and in effect taxed at their rates of income tax. The trustees would retain full control over the properties and how the income is distributed. You and your husband could be trustees, while a professional co-trustee is often helpful to help navigate the rules and administration.

If in the future, the trustees decide to pass the ownership of the properties to your children personally, the same CGT holdover relief is available. The properties pass to your children CGT free, with the unrealised profit only taxed when your children come to sell them.

The trust does have a potential IHT charge every 10 years or when the properties are distributed. However, due to the way the rules work, where there is no IHT when the properties are transferred into the trust (which would be the case for you), there is no IHT on distributions out in the first 10 years. Consequently, the trustees should weigh up the asset protection advantages of continuing the trust after the first 10-year anniversary, against the tax costs of doing so.

We’re going home to Brazil — what happens to our UK taxes?

My husband and I have lived in the UK for 25 years. However, political volatility, policy changes around non-dom status and rising debt in the UK have led to us making the tough decision to return home to Brazil. 

I know the move should result in a lower tax bill — at least in the UK — but feel I need guidance on how to achieve this. We own our home in the UK, and all our investments are here. Do we need to sell everything before we leave? What about making gifts to our daughter, who will continue to live in the UK?

Lara Mardell, legal director at law firm BDB Pitmans, says the starting point is to ensure you know exactly when you become non-UK tax resident. UK tax residence is determined by the Statutory Residence Test (SRT). A person’s residence in a tax year depends on how long they have been here, certain “ties” they have, and how many days they spend here. You probably need to restrict your days to either 90 or 119 in a tax year, but it may be fewer. 

You will probably be resident or non-resident under the SRT for a full tax year — your tax residence may cease after you have left, at the start of the next tax year on the following April 6 (though so-called “split year” treatment might apply).

If you become tax resident in your homeland at the same time as being tax resident in the UK, the tax treaty between the UK and your home country should determine which you are resident in.

Regarding your investments, although you are non-domiciled you have been in the UK for a long time and will remain “deemed domiciled”, so taxed like any other UK resident. You pay UK income tax on your worldwide income. When you are non-resident in this country you pay income tax only on certain types of UK source income, and the income from most of your investments is likely to be disregarded, though any rental income from UK property is taxable. So there is probably no immediate need to sell. 

If you have assets which stand at a gain it is probably better to sell them — or gift them to your daughter — when non-resident. UK residents pay capital gains tax (CGT) on gains realised on UK assets (and usually on non-UK assets as well). Non-UK residents do not generally pay CGT on gains, even on sales or gifts of assets in the UK (apart from real estate) — though if you become resident again within five years, gains realised while non-resident will become chargeable.

A big question is over your UK home. From a tax perspective, selling your home while still UK resident or very soon afterwards can work well. Retaining it is a tie for the purposes of the SRT, so that means fewer permitted days in the UK. The home is not a tie if you rent it out, but the rent will be subject to income tax. 

Another advantage of selling while you are still UK resident (or soon after) is CGT. Unlike on most assets, non-UK residents pay CGT on gains on sales of UK real estate (though only on gains since April 2015). UK residents do too, but they are likely to have the benefit of principal residence relief on the sale of their home, which provides full relief from CGT. Non-UK residents can also qualify for this relief too, though after nine months of ceasing to live in the property, this relief usually starts to be eroded. 

The opinions in this column are intended for general information purposes only and should not be used as a substitute for professional advice. The Financial Times Ltd and the authors are not responsible for any direct or indirect result arising from any reliance placed on replies, including any loss, and exclude liability to the full extent.

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