Landlords of rental property often consider transferring property into a trust or as a gift to children as a more tax efficient alternative. Our guide details the tax implications of this option.
What is a trust?
A trust is a way of managing your assets, in this case property, by transferring them to another person, either a child or family member. Although technically the property will no longer be in your name, you will still have some control over how the property is used. Trusts are set up for a number of reasons. These can include preparing for inheritance tax, controlling or protecting family property, or in the case that the trustee is too young or incapacitated to manage their own affairs.
There are three main parties involved in the process of transferring property into a trust. The settlor establishes the trust by transferring the property. The trustee is the person in charge of managing the trust. The beneficiary is the one who will benefit from the trust. As the new legal owner of the property, the trustee manages it according to the settlor’s wishes outlined in the deed. An example of a beneficiary could be a child, who will gain control of the trust when they reach a certain age or in some cases, upon the death of the settlor.
What are the two main types of trust?
There are two main types of trust:
- Interest in possession trust
In this case, the entitlement is fixed and the beneficiary must receive the income or entitlement of the trust.
- Discretionary trust
This type of trust depends on the discretion of the trustee. They have control as to when or whether any income or capital of the trust is granted to the beneficiary.
Particularly in the second case, it’s advisable to have a minimum of one independent trustee who is not a beneficiary.
What are the taxation implications of a trust?
Transferring property into a trust is not without tax implications, however. Each type of trust is taxed differently, and for each party involved. In the case of a discretionary trust, for example, trustees are required to pay tax on any income accumulated by the trust. The amount changes depending on the number of trusts the settlor has. Trustees don’t qualify for dividend allowances either for a discretionary trust.
Trustees pay tax on interest in possession trusts, but it’s paid at different rates. Dividend-type income tax is paid at 7.5% and other income is paid at 20%. The trustee can also pass these responsibilities to the beneficiary who will then need to manage their own self-assessment.
Advantages and disadvantages of a trust
One of the main advantages of a trust is to ensure the control and protection of your assets. As a settlor, you decide on how you want them to be dealt with and how your loved ones benefit. It’s also a way to set up certain conditions, for example, if you would like to give your property to your child but only when they reach a certain age. A trust is also a way to minimise inheritance liability, protecting the future finances of your family.
The drawback is mainly that the settlor must relinquish legal title to the trust property, and this is irreversible. For this reason, it’s not a decision to be taken lightly. Although, by setting up a trust you will also be able to control the terms in the deed, which will give you peace of mind, even though the asset is no longer in your name. A financial advisor will be able to help you with the details setting up your trust, so you will have a certain level of control over what happens to your property.
Another disadvantage of transferring property into a trust as a gift or to children is that all settlors, trustees and beneficiaries are likely to incur related taxes and other charges. These include:
- Capital gains tax
If the property that’s put in a trust increases in value then capital gains tax will be charged against this gain. The person who’s responsible for paying capital gains tax depends on the situation. Upon putting the property into a trust, capital gains tax is paid by the person selling the property or the settlor. If the trustee then transfers or sells the property on behalf of the beneficiaries, they need to pay capital gains tax. Once the beneficiary becomes completely entitled to the property, they are then responsible for capital gains tax based on the current market value
- Inheritance tax
Inheritance tax is due at the time of transferring property into a trust. When the trust ends inheritance needs to be paid again in the form of exit charges. Trusts also occur 10-yearly inheritance tax charges.
Potentially Exempt Transfer (PET)
Transferring a property into a trust as a gift or to children is a means to securing your assets, but it’s important to account for these additional costs. There is a way to avoid inheritance tax in particular, however. If the settlor survives the gift for seven years after they will be entitled to transfer assets free of inheritance tax.
Seek financial advice
If you’re considering transferring property into a trust, then it’s recommended to seek financial advice to ensure that you and your family benefit as much as possible. There are many advantages to setting up a trust. It gives you peace of mind knowing that your assets are protected. You can plan ahead for the future, securing your family’s finances.
A financial advisor will be able to outline all the tax implications related to transferring property into a trust and explain any necessary costs. There are several types of trust and the conditions depend on a variety of factors. There are also possible exemptions from certain taxes, and a financial advisor will be able to let you know if you’re eligible. If you would like to discuss the tax implications of setting up a trust, get in touch today