How to protect your property portfolio from inheritance tax when you die?
When you die, your investment property will form part of your estate. If your whole estate is worth more than £325,000, then your heirs may have to pay inheritance tax. With property prices rising so much in recent years, you might be worried that inheritance tax might destroy the value of your property investment legacy to your heirs.
In this post, I look at inheritance tax on the investment property in a little more detail. When you know how much inheritance tax is paid on investment property, you’ll be able to plan for it. This means your investment property can do what you hope it will after you’re gone.
Who has to pay inheritance tax on your investment property?
When you die, your estate will be distributed according to your will. The recipients (beneficiaries) of your estate are responsible for paying the inheritance tax, but in practice, this works differently. The inheritance tax that is due will be calculated by the person dealing with your estate (called the ‘executor’). They will arrange payment of taxes from the estate. They will also pay other taxes, such as tax owed on rental income you received before you die.
How much inheritance tax is paid on your investment property?
The inheritance tax owed is calculated on the whole estate. Let’s say that you only own an investment property and that it is worth £400,000 tax is charged at a flat rate of 40%, and on any value of the whole estate over £325,000. In this example, the inheritance tax paid on investment property is £300,000 (40% of £75,000).
If you inherit an investment property, remember that you’ll pay income tax on the rental income.
Do your heirs have to pay capital gains tax, too?
If you sell an investment property before you die, you’ll be liable to pay capital gains tax on it. This is charged at either 18% or 28%, depending on your income tax position. However, when your investment property is inherited, there is no capital gains tax to pay. Investment property, like other assets, is inherited at ‘probate value’ − this simply means its value on the date of death. It is this value that is used when calculating how much tax is paid on investment property and the rest of the estate.
If you leave your entire estate to your spouse or a civil partner, there won’t usually be any inheritance tax to pay. In this case, inheritance tax will be payable on the surviving spouse’s estate.
Can I reduce how much inheritance tax is paid on my investment property?
There are several strategies that you can use to reduce the amount of inheritance tax you pay on your investment property. These include various trusts and life assurance. If it is set up correctly and regularly reviewed, a life assurance policy will pay any inheritance tax due and allow your entire estate to your beneficiaries.
Why is it important to understand inheritance tax and investment property?
Investment property is a stand-out asset for both capital growth and income. If you bought an investment property portfolio 20 years ago, it would be worth substantially more today. In fact, average house prices in the UK have almost quadrupled since 1996. Let’s say you invested £200,000 in property in 1996. Today that would be worth almost £800,000.
Assuming this is your only asset, working out how much investment tax is paid on investment property comes to a figure of £190,000. Your heirs may have to sell some properties in the portfolio to pay this property tax. If you have life assurance with an insured amount of £190,000, it can be structured to pay the inheritance tax for you and leave the investment property portfolio intact.
As your investment property portfolio grows, it’s important to maintain a watchful eye on inheritance tax. This is one reason why we recommend that property investors review their portfolio every year. If you haven’t done so in the last few months, call us on +44 (0)207 923 6100. We will be pleased to discuss your options to ensure your investment property works for those you leave behind in the future as well as you today.