Gift of a holiday home
You want to pass on your second home to your children as part of an Inheritance Tax planning exercise, but there is likely to be a large Capital Gains Tax bill to pay. Is there any way to avoid this tax charge?
Passing things on
Recap. Passing on your assets during your lifetime generally reduces the value of your estate which is subject to Inheritance Tax (IHT), meaning less tax is payable on your death. The value of the gift made to an individual will drop out of your estate completely once you have lived seven years from the date you made it.
CGT trap. Unfortunately, for Capital Gains Tax (CGT) purposes the transfer of a property to a relative who is not your spouse, is taxed as if you had sold it at the full market value. Where you have held the property for some years it is likely to have increased in value, and that gain will be taxed at 40% (in 2007/8) or at 18% (in 2008/9). As you have not lived in the property as a main residence, there is no exemption from CGT on the gain in value.
Use a trust?
One solution is to transfer the property to a discretionary trust set up to benefit your children. The value of such a gift is potentially subject to IHT and the gain on the property is also subject to CGT. To avoid this double taxation you can elect to hold over the capital gain under s.260 of the Taxation of Capital Gains Act 1992 (TCGA) which leaves no CGT to pay on the gift. There is also no IHT to pay if the value of the property is less than your unused nil-rate band for IHT (£300,000 for 2007/8 and £312,000 for 2008/9).
Downside. When the property is eventually sold, all of the gain built-up when the property was in your hands becomes taxable, as well as any increase in value achieved since the date of the gift. What’s more, even if the property has been occupied by your child as their main residence, the CGT exemption for a main residence does not apply.
As a business asset. If the property is classed as a business asset, you can gift it directly to your children and hold over the capital gain under s.165 TCGA. Business assets include properties that have been let commercially as furnished holiday lettings.
Tip 1. Where you have a second home which you would like to pass on to your children free of tax, let it out furnished for a couple of seasons (see The next step for the conditions a property must meet to qualify as a furnished holiday let).
Tip 2. The property does not have to be in a traditional holiday location to qualify as furnished holiday accommodation. Any furnished property located in the UK can qualify. A bachelor pad in the centre of Oxford would qualify as much as a flat in Brighton.
Final sale. If it’s a business asset, there is no bar on your offspring claiming the CGT exemption for living in the property as their main home, if they have in fact done so. This means the gains that built up on the property while it was in your hands have escaped tax completely. The gains made since the date of the gift are exempt due to the main residence exemption.
The next step
For the conditions a property must meet to qualify as a furnished holiday letting, visit http://tax.indicator.co.uk (TX 08.12.03).