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Are you walking into an inheritance tax trap?

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As house prices have risen and inflation has gone up, it is estimated that as many as 800,000 UK homes have now surpassed the value of £1m in 2019.

That might sound like purely good news, but many people living in these properties are unaware that this increase in the value of their home now leaves their estate liable to inheritance tax.

Indeed, it is now not unheard of for people to have spent decades only ever paying the Basic Rate of Income Tax (20%), only to face a huge 40% tax on their assets valued over the inheritance tax threshold.

Unfortunately, this isn’t the only “inheritance tax trap” which people unintentionally fall into. In the Daily Telegraph, for instance, Harry Brennan notes that over the past three years, nearly £372m has been claimed by the taxman due to “gifts gone wrong” during poor inheritance tax planning. This is particularly due to mistakes made over the “gift with reservation” rule when gifting property to children, which will explain in a bit more detail below.

Given the hard work you have put into building your estate over many years, and the significant sums of personal wealth involved, it is vital that you plan your wealth carefully and seek the counsel of an independent financial adviser, to help you navigate these complex issues.

In this article, we will be sharing a bit more information about some of the prominent inheritance tax (IHT) traps to be aware of in 2019, to clarify your thinking and discuss further with your adviser. Please note that this content is for information purposes only, does not constitute financial advice which should be sought before any action is taken. To receive regulated, impartial financial advice into your own affairs, please consult an independent financial adviser such as Castlegate Financial Management who are a firm of Chartered Financial Planners.

Trap #1: The “property value trap”

As mentioned above, rising property value and inflation have led many homeowners to cross over the IHT threshold without realising. Whilst property prices have certainly not risen all across the UK, many areas have seen significant value increases.

In the Notting Dale ward of Kensington and Chelsea, for example, prices have gone up, on average, by £260,000 between 2007 and 2016 (i.e. from £340,000 to £600,000). In one part of South Buckinghamshire, moreover, house values have skyrocketed from £275,000 in 2007 up to £700,000 in the same time frame.

Why have value increases placed some people unwittingly into the IHT line of fire? It comes down to the rules governing how your assets are taxed upon your death.

In 2019-20, your “estate” (e.g. your property and possessions) generally faces a 40% IHT bill once your assets exceed £325,000. There are situations where you can pass on more without facing IHT, however. For instance, if you pass on your own home to a direct descendant (e.g. a child) then in 2019-20 you can usually raise your IHT threshold by £125,000 under the additional residence nil rate band” rules.

Naturally, if your property increases in value to the point where it exceeds your IHT threshold, then you might unknowingly be facing a 40% tax on your assets beyond this point.

Trap #2: The “not married trap”

In many ways, current IHT laws in 2019 still reflect British society in the 1800s when most people married and very few cohabited. Many cohabiting people are unaware of this and as a result, they mistakenly believe that they will receive their partner’s assets “IHT-free” in the tragic event that they were to die before them.

The fact is, whilst spouses and civil partners can usually inherit their deceased spouse’s/civil partner’s assets without facing IHT, this benefit is not available to cohabiting partners. This is the case even if you have lived happily together for many decades and have had children together.

As a result, many people are unwittingly facing a 40% tax liability on their partner’s assets if they die prematurely over the IHT threshold. If this person owns your home, then this could unfortunately even lead to the sale of the property in order to meet an IHT bill.

We are not recommending that you run to the altar, by mentioning this! Only that you speak with a financial adviser about how you can best plan your estate, in order to be prepared in the event that the worst happens to one of you. The same applies for friends or siblings who have possibly lived for years together in old age, who might face a similar situation.

Trap #3: The “gift trap”

Many people are aware of the rule that you can usually give away part of your estate and avoid paying IHT on that gift if you die at least seven years after making it.

What some people fail to realise is that this rule does not apply if you “reserve a benefit” on the gift. Perhaps most commonly this mistake is made by parents who continue to live in their property but gift it to their children (without paying a market rent), to try and reduce their IHT.

You should speak with a financial adviser if you are considering gifting your home whilst continuing to inhabit there. Done incorrectly, not only might your actions be regarded as “deliberate deprivation of assets” by a local authority, meaning your home is still factored into your means test for working out care costs, but also fall into your taxable estate for IHT purposes. Your children will also be likely to pay Capital Gains Tax on your property from the date of the gift when they eventually do sell it.

Final thoughts

IHT is a notoriously difficult area of wealth management to navigate, where mistakes are both easy to make and deeply felt. At Castlegate, we have experience across Lincolnshire and the wider area helping clients prepare their estate effectively for their loved ones. If you would like to speak to us about your own situation, then please get in touch to arrange an initial, no-commitment financial consultation at our expense with a member of our team.