Inheritance Tax Planning on Buy To Let Properties

With inheritance tax sitting at 40% for an estate above £325,000, a landlord’s next of kin could be set to lose a large amount of money to the HMRC after they die.

Here we are going to go through the Inheritance Tax rules with regards to Buy-to-let properties, and talk over the options available to you to keep your portfolio as tax efficient as possible for your children.

What Are the Inheritance Tax Rules Around Buy To Let Properties?

In most circumstances, Buy-to-let properties would count towards an individual’s estate.

At the time of writing (September 2024) Inheritance Tax is set at 40% on anything above £325,000 (the zero tax threshold for Inheritance Tax). The majority of Buy-to-let properties would count as part of this estate.

So the default Inheritance Tax on Buy-to-let properties is 40%.

Business Property Relief

This rule is muddied however by Business Property Relief (BPR). 

Business Property Relief can allow you to bypass inheritance tax on a property you own if you run the property as a business rather than as an investment.

This business/investment distinction is unclear, but obvious examples of properties being run as businesses are:

• Holiday homes where you act as a tour guide as well as a host.
• Commercial properties where you offer business support (IT infrastructure for example) as well as leasing out the building itself.

The UK government is trying to crack down on landlords (ab)using BPR, so whether a Buy-to-let qualifies for BPR is often decided on a case by case basis. 

A good rule of thumb is that if you put at least 80% of your rental yield back into your business then it will likely be eligible for Business Property Relief. This includes paying yourself as a director of the business.

Your property is more likely to qualify for BPR if you keep a record of your personal hours working in the property/business.

What are Your Options When it Comes to Inheritance Tax and Buy To Let Properties?

For the rest of this article we are going to assume that your property does not qualify for Business Property Relief and that the default will involve paying 40% Inheritance Tax after you die.

Here are your options for reducing this figure.

Gifting

Gifting is where you give the Buy-to-let property to your next of kin. 

If the gift is given more than 7 years before you die then it is exempt from Inheritance Tax.

There are some disadvantages to this however:

1. Gifting a Buy-to-let means gifting any rental yield: So if you are living off rental income then this isn’t an option. I’d strongly recommend avoiding any loopholes around giving a property and then claiming the rental income back through informal means. The risks are too high.
2. You have to pay Capital Gains Tax when you gift a property: This is calculated by substituting the current price of your gifted property from the amount you spent on it. These expenses include money spent on buying, renovating and maintaining the property. Capital Gains Tax is 18% if you’re a basic rate taxpayer and 28% if you are a higher rate tax payer.

If your property is mortgage free then you may be eligible from the Rental Property Income Protection Plan introduced in 1986.

This allows you to gift 50% of the property, split the rental income with your beneficiary and avoid paying Inheritance Tax if the gift was made 7 years before the owner died.

The disadvantage here is that you have to pay Capital Gains twice, once when the 50% gift was given and again when the other 50% is inherited. 

If the property’s value goes up significantly over this time then it could be more tax inefficient than gifting outright. However bear in mind that your rental yield may offset this.

We’d only recommend outright gifting if you can live comfortably without rental income.

If losing out on rental income puts you in an insecure financial position then we would not recommend gifting. 

You may consider using the Rental Property Income Protection Plan if your property is mortgage free.

Incorporation of Your Property Portfolio Into a Limited Company

A second option is to incorporate your property portfolio into a limited company.

This gives you the options of:

• Gifting shares in the company to your children
• Making new acquisitions using Directors’ Loans which means that any growth of the company’s value is divided among shareholders (including children) rather than just the landlord

Shares (which may grow in value over time) gifted before 7 years of the gifters’ death will not be subject to inheritance tax.

The company as a whole will be subject to corporation tax, however. This currently sits between 19% and 25% depending on how much profit you have made that year (it works on a sliding scale rather than in bands like income tax).

You’ll also have to pay Stamp Duty Land Tax and (possibly) Capital Gains Tax when you incorporate your property portfolio into a limited company. 

You will lose money in the short term for your children to gain in the long term.

We recommend incorporation to landlords who are young enough that they can be confident that they will not die within 7 years of gifting shares, who want to grow their portfolio and who are willing to pay corporation tax on their rental profits.

Essentially, younger, more ambitious landlords who see it as their main profession rather than a side income or retirement plan.

What If I’m Retired and Reliant on Rental Income?

If you are retired and reliant on rental income and you fear that corporation tax may affect your financial security, then your best option is just to bite the bullet on the 40% income tax.

Inheritance Tax will not be reduced anytime soon now that Labour have come into power so you will just have to accept that your children may lose a large chunk of your property portfolio to the HMRC.

Summing Up

Hopefully this has given you some clarity on your options for minimizing the inheritance tax that you have to pay as a landlord. A quick summary of this is:

• If you can demonstrate that your Buy-to-let property is run primarily as a business and not as an investment then it could be exempt from inheritance tax altogether. You’ll need to reinvest at least 80% of your rental income back into your property to qualify for this.
• If you are willing to give up your rental yield then you can gift your property to your children. If the gifting occurs 7 years before your death then the property is exempt from inheritance tax. You will lose your rental income as soon as you gift a property.
• You can gift 50% of your property to your children and keep your rental yield, however you will have to pay Capital Gains Tax (18% – 28%) twice. Once when you gift the first 50% of your property and again when your next of kin inherits the other 50%.
• You can incorporate your property portfolio into a Limited Company and gift shares to your children. This allows you to bypass Inheritance Tax but does mean that you have to pay Corporation Tax (19 – 25%) on your profits every year.

This article was written by Charlie Bailey. Charlie is the Co-Founder of Accounting Firm GoForma.