This article first appeared in the Winter 2021 edition of Scottish Land & Estates LandBusiness magazine.

With land and property prices having risen so much in recent years it continues to be a challenge to pass on these assets without incurring tax. 

This is especially the case when the assets are residential and/or commercial property. Many tax reliefs normally available to trading assets and farmland are simply not in point for what HMRC regards as a non-trading activity: the letting of residential and commercial property.

With careful planning though it is possible to still manage the succession of these assets with minimal tax leakage.

Till death do us part

An advantage of having a spouse or a civil partner is the tax breaks it affords. At the most straightforward end of property planning, consideration can be given to passing the asset on through your Will to your spouse/civil partner. There is no Capital Gains Tax (CGT) payable on death; instead a tax free uplift to market value of the properties and no inheritance tax on the basis of the spousal exemption applying. 

Now the surviving spouse has the property assets held at market value and can make gifts of the assets to next generation with little or no capital gains tax and provided the gift is survived by seven years there's no Inheritance Tax (IHT) exposure. 

Trust to the rescue

For properties worth a total value of £325,000 or for spouses looking at making a gift up to £650,000, then a Trust structure can tap into CGT ‘holdover’ relief which wouldn’t otherwise be available for this type of asset class. This is particularly good for a property asset sitting with a significant gain as the gain is deferred on the transfer into Trust and the Trust takes on the original base cost or March 1982 value of the property if acquired prior to then.

This manages the succession of smaller scale properties or property assets that could increase significantly in value in future years into a protective structure that you can still control but let the next generation benefit from. From an IHT perspective after seven years the asset is outside of your estate. In due course the asset can also transfer out of the trust and the gain be held over, ultimately seeing the asset passing into the hands of the next generation with no capital gains tax cost attached.

Countryside appeal

If the property you hold is let agricultural property which qualifies for Inheritance Tax Agricultural Property Relief then a special form of CGT holdover relief again applies. Such assets can include farm cottages and farmhouses occupied for agricultural purposes. These assets can be passed on and the capital gains tax position managed when transferred as part of transfer of land which includes part of the agricultural land.

Generally rental businesses will not qualify for Inheritance Tax Business Property Relief, and so may be exposed to IHT on death. Where either commercial or residential let property is held as part of a wider business, it may be possible to argue that there is only one “hybrid business” consisting of different activities. Where business consists of more than 50% non-investment activities looked at “in the round” and considering various factors (e.g. turnover split, profit split and capital values), then the whole business, including the rental properties, may qualify for Inheritance Tax Business Property Relief, which may provide relief from Inheritance Tax. This is a complex and fact specific area, but it is possible to seek a clearance from HMRC on the Inheritance Tax status in the right circumstances. There would also be a CGT uplift in values within the deceased’s estate if assets pass on death.

If seeking to pass assets on in lifetime then the creation of a Company or Trust structure may be a means of getting the assets out of your hands and on to the next generation whilst mitigating taxes.

Incorporation relief as a solution

Incorporation can be a good choice for standalone commercial and/or residential property portfolios. 

Provided on analysis there is a property "business" then it may be possible to manage the incorporation of that portfolio in exchange for shares in the Company. Applying incorporation relief will see the company acquire the properties at their market value, which creates flexibility for the Company to restructure its property holdings going forward without incurring Corporation Tax on chargeable gains. The use of share discounts can, in the right circumstances, be used as a means of then passing shares around the family and managing the capital gains tax payable, but care is required around this and the rules work differently for IHT.

In all the scenarios set out above, other taxes such as Land and Buildings Transaction Tax and VAT must be considered, also any gift made to be effective from an IHT perspective must be made outright.­­

Get in touch

If you would like to find out more, please don't hesitate to get in touch with myself, a member of our Tax or Rural teams, or your usual Johnston Carmichael adviser.