Escrow of an investment property for family members (2023)

Lee Sharpe discusses the tax aspects of using funds to hold investment property for dependents.

This article is based on English law and readers should note that there are differences between UK jurisdictions. The treatment in the EU and outside can also be very different.

Why use a trust?

Trusts often pay very high taxes. However, in some cases they are well positioned to hasten a person's desires, such as:

1. Legally own property for the benefit of young children until they are old enough to take direct possession of it.
2. Granting someone temporary probate benefits until they pass to the intended beneficiaries (usually a will providing assets to be supported by/to provide income, surviving spouse as "life tenant" until passed to the children of the marriage).
3. To protect assets from "lavish" beneficiaries or claims from "bad marriages" etc. so that one cannot be forced to cede the underlying assets to creditors or other claimants, usually valuable assets such as the family home or family business shares.

Keep in mind that it's relatively rare these days that one of those reasons is simply to save on taxes (although you'll put life insurance into a trust so that on death/claim it comes out of the taxable estate for tax purposes). . income tax). Inheritance (IHT), is a relatively simple and common tax saving measure).

Basic Use of Trusts: Typical Intergenerational Life Planning

Parents and grandparents who are home owners can get to the point where they don't really want to own investment properties that generate more income than they need (and pay income tax) and risk increasing their income risk. IHT in death

The easiest way to solve this growing problem would be to give your adult children or even your adult grandchildren a rental home or apartments. As long as they survive the donation for at least seven years, they will lose ownership of their property upon death and fleeing the IHT. However, there is usually a significant Capital Gains Tax (CGT) on this lifetime transfer.

Aside from spouses/partners, there is no automatic CGT exemption for discounted donations or referrals. A gift or discount sale of property to another family member generally results in a CGT liability as if the asset had been sold at fair market value. Put simply, HMRC is not too concerned about a lack of cash receipts to pay the CGT owed.

It is also important to note at this point that from 6 April 2020 individuals (and certain other taxpayers) will be required to submit a declaration and payment to HMRC for any disposal of UK property within 30 days of completion afford ; this is in addition to any ongoing taxpayer self-assessment reports. Although this new rule only applies where the CGT has jurisdiction (i.e. transfers between spouses/companions in a committed relationship are not included or if 100% of the gain is covered by the sole or principal residence tax exemption), gifts will generally be treated as above taxed, and owners and their representatives should be aware that penalties for non-compliance under this new regime may be imposed well before the normal self-assessment reporting deadline.

Postponement of CGT collection to fiduciary submission

Many mature landlords have assets tied up in their properties, but relatively little money. Therefore, it would be counterproductive to transfer an investment property to avoid an IHT fee, which can take many years, only to immediately bear a 28% CGT fee.

In general, you cannot “hold” (or defer) the capital gain on an investment property transfer because it does not qualify as a qualifying trading asset (generally, in this context, a qualifying asset used in a trade). Properties that meet the criteria to be treated as furnished vacation homes (FHA) are one of the main exceptions; Another that we will focus on here is where transmission could lead to immediate or lifelong exposure to IHT.

The gist of this exception is that a transfer to a discretionary trust will result in a lifetime fee on the IHT, so the applicable CGT may be deferred, but that IHT fee may be void, typically where the property donated is worth less than the donor IHT Zero Rate Band. That's currently £325,000; but note:

• Any transmission subject to the IHT charge in the past seven years may potentially reduce the zero-tariff band available for that transmission to zero; But
• Couples can "double" the amount they can transfer when they switch joint ownership.

Remember that at this stage it is the value of the property being transferred to the trust that is relevant, not the profit.

As long as the property is held in trust

Trustees act as custodians of assets and the income derived from them. The settlors, in this case the parents or grandparents who 'arrange' the property in the trust, give a set of instructions in the form of a trust deed on how to look after the property, use any income and ultimately distribute any property it becomes available, trust matures. Settlers can also be healers, but:

• The property no longer belongs to them personally, they just take care of it;
• You must follow the instructions of the Trust Deed; It is
• You must administer the estate in the best interests of the parties who intend to benefit from the trust (ie the beneficiaries).

A discretionary trust pays a 45% penalty on all rental income while the property is held by the trust. However, since the income is attributed to the beneficiaries, they receive a 45% income tax credit and if a beneficiary is taxed less than 45%, they receive a refund of the difference.

Beware of foreclosures

Cash transfers work best on non-mortgage properties because:

• The mortgage lender may have legal powers to block the transfer (or charge a participation fee); It is
• Trustees may be subject to stamp duty (or equivalent charge) because they have agreed to assume the burden of the mortgage when they take ownership. A similar fee may also apply to a wire transfer.

Settlers should not benefit

Escrow planning is largely ineffective if the trustor retains any rights to the property, such as B. the right to rental income or the right to occupy the property. The settlor is automatically deemed to "retain an interest in the estate" if the settlor (or his or her spouse or domestic partner or children under the age of 18) are able to benefit from the trust property.

For this reason, these trusts are usually created for adult children; young grandchildren will not automatically trigger anti-circumvention provisions.

How long does the rental stay in the background?

Trustees may be able to use the same CGT/IHT agreement to transfer trust assets to beneficiaries in a very short period of time. The property does not "escape" from the CGT because the beneficiaries purchased the property from the setters at the original land cost, so they pay the full amount of the CGT when they sell the property.

Discretionary funds are sometimes used for precisely this purpose: passing a property on to the next generation at a significant profit without triggering a CGT account that no generation could pay without even selling the property.

Alternatively, the property could remain 'protected' within the trust for many years, paying rent to the children until (say) the youngest grandchild is old enough to legally own their share of the property. In this case, the trust is exposed to the IHT:

• On every tenth birthday; It is
• When the property exits the Fund (i.e. the “exit rate”).

However, the IHT rate is relatively modest (i.e. no more than 6%) and is calculated only on the surplus value deemed to have accrued above the zero rate band(s) upon transfer to property The collection of IHT may also be zero remain.

Diploma

Trusts can be useful for holding important assets for the benefit of family or loved ones, either as a long-term vehicle or simply as stepping stones to transfer to adult beneficiaries. In any case, advice from a suitably qualified professional is essential. It can be very expensive to reverse trusts when they don't work as expected.

Lee Sharpe discusses the tax aspects of using funds to hold investment property for dependents.

This article is based on English law and readers should note that there are differences between UK jurisdictions. The treatment in the EU and outside can also be very different.

Why use a trust?

Trusts often pay very high taxes. However, in some cases they are well positioned to hasten a person's desires, such as:

1. Legally own property for the benefit of young children until they are old enough to take direct possession of it.
2. Granting someone temporary probate benefits until they pass to the intended beneficiaries (usually a will providing assets to be supported by/to provide income, surviving spouse as "life tenant" until passed to the children of the marriage).
3. A

... Tax Insider Share: Entrusting an investment property to family members in trust