Reducing Inheritance Tax on Parental Residential Properties

For many families, the bulk of their family wealth will be tied up in their residential property. From an Inheritance Tax perspective, this means that any amounts in excess of the Inheritance Tax threshold of £325,000 per person (£650,000 per couple) will be liable to Inheritance Tax at a rate of 40%. This, in turn, means that for each £100,000 of the estate over these thresholds, the children would only be able to benefit by £60,000. Therefore it can be seen that finding ways to reduce Inheritance Tax on parental residential properties can help the children significantly.

Strategy one

One way round the problem would be for the parents to take out a mortgage on their home and then gift the sum received to their children. This would reduce the value of the property by the size of the mortgage provided the parents were to survive for 7 years after making the gift.

Historically there have been two main issues with this course of action:

  1. Firstly parents may not be able to afford the monthly mortgage payments, especially if they are living off their retirement income.
  2. Secondly the mortgages that used to be available to older people had high interest rates which generally made this type of financial planning ineffective.

Considering the first issue, one way round this for parents with grown up children who are earning a comfortable living themselves, would be for the children to pay the monthly mortgage costs as they are the ones that would be benefiting by this type of planning.

Moving to the second issue; in the past the interest rates for “equity release” or “lifetime mortgages” tended to be around 5.5%. The interest was not paid monthly but instead rolled up over the life of the loan and then repaid on death. The problem with the interest compounding in this way was that it became very expensive.

For example a £200,000 loan at an interest rate of 5.5% where the interest rolled up over 20 years would lead to an eventual loan repayment of £599,000.

Strategy Two

Recently, there has been a range of new mortgage products, targeting older borrowers, released onto the market with lower interest rates and which allow the borrower to pay off the interest on a monthly basis. If therefore the borrower has older children, for example in their 40s or 50s, they could take out a loan and gift the money to these children.

The children in turn would be responsible for the monthly mortgage payments. Provided their parents survive 7 years, the gift will be outside of their estate and not liable to Inheritance Tax. The Interest on the loan will have been paid off as it was incurred rather than escalating via roll up. This strategy would therefore enable families to reduce inheritance tax on parental residential properties and at the same time to free up money for their children when it is perhaps most needed.

It must be noted, however that this type of planning requires careful consideration and it is recommended that expert advice is sought before any action is taken. Contact us for professional financial advice today.