Save inheritance tax and reduce your capital gains tax bill
One of the best ways to reduce inheritance tax (IHT) on your death is to give away assets during your lifetime. The problem is, a gift can trigger a large capital gains tax (CGT) bill if the asset has gone up in value during your period of ownership. That has always been a big disincentive to lifetime giving.
Now that asset values are falling, the CGT burden will often be far lower. Suppose you give your daughter some shares which you bought for £100,000 in 2002. They were worth £180,000 in 2007 but are now only worth £120,000.
If you give them to your daughter now, you pay CGT based on today's low market value of £120,000 so your taxable gain is just £20,000. Compare that to a taxable gain of £80,000 had you made the gift in 2007. You also have an annual CGT exemption of £10,100. On top of that, the CGT rate is now just 18% so your CGT bill on the gift would only be £1,782.
Compare that to the much larger potential IHT saving of 40% of
the value of the shares on your death.
Use losses to cut your CGT bill
If the shares are actually worth less now than you originally paid for them, and you give them away, you will make a loss that you can use to reduce your taxable gains on the disposal of other assets. If you don't have any gains at the moment, you can carry forward the loss indefinitely and use it against any future gains when the market picks up again.
Now suppose you really want to keep your shares but you still want to trigger the loss to offset against a gain on another asset.
In that case, you could sell the shares and then buy them back again (but not within 30 days). Alternatively, you could transfer the shares into a family trust or if you aren't married but are in a relationship, you could transfer the shares to your partner.
Then on a later sale of the shares by the trustees or your partner, their base cost will be today's lower value.
In effect you will have deferred CGT on the sale of your other asset until a later sale of the shares, which most likely could be years away.
Reclaim tax and reduce your CGT liability from 40% to 18%
If you sold an asset at a profit in the last three years and you have already paid CGT on the gain, you should consider investing in Enterprise Investment Scheme (EIS) shares. This allows you to reclaim the tax you have already paid, which may have been at 40%. Instead the gain is rolled over into the EIS investment so that it only becomes taxable when you eventually sell the EIS shares.
Apart from the cash-flow benefit of deferring the tax, the other big advantage is that the tax rate will then be just 18%. In effect you are converting the rate of tax from 40% to 18%. Income tax relief is also available at 20% on the amount you invest as well as CGT exemption for any profits you make on the EIS shares themselves when you eventually sell them. However, EIS shares can be high risk investments and may not be suitable for all.
Avoiding tax on gifts to family trusts
You may be keen to reduce your taxable estate but reluctant to make outright gifts to your children, especially if they are financially immature or you have concerns about their possible divorce or bankruptcy. You may have instead considered using a trust but been put off by a possible CGT charge when transferring assets to the trust. Similarly you may have been deterred by the upfront 20% IHT charge that applies on gifts to trusts where the value of the assets exceeds the nil rate band (currently £325,000). But now that values have fallen, you might be able to avoid both taxes, making this an ideal time to put assets into a family trust.
Take John, who owns a buy-to-let property. He bought it for £200,000 in 2001. In 2006, it was worth £400,000 but now it's only worth £300,000. If he transfers the property to a family trust for his adult children and grandchildren, he can "hold over" or defer the £100,000 gain so there is no immediate CGT charge. Nor does he pay IHT on the gift to the trust because the value of the property (£300,000) is now within his nil rate band. For many this could offer a once in a lifetime tax planning opportunity.
Gifts of assets with high-growth potential
You can give away an asset now while its value is low and if you then die within seven years when it's worth far more, it's only today's lower value that counts for IHT purposes. For example, Adam gives his daughter a painting in 2009 when it's worth £500,000. He dies in 2011 when the painting is worth £800,000. It is today's lower value of £500,000 that counts for IHT. Even though Adam did not survive seven years, he has still made a significant IHT saving by making a lifetime gift of the painting to his daughter now rather than leaving it to her on his death when its value has increased.
Having your cake and eating it
If you own an investment that's fallen in value, you might want to give it away now, knowing there will be little or no CGT to pay. The problem is, you may still need the income for a few more years. In that case there is a tax-efficient solution which is particularly suitable where the investment is likely to increase significantly in value.
Take James as an example. He owns an investment property which has recently fallen in value. James does not want to give the property to his children right now as he still wants the rental income, so instead he agrees to sell it to them now for a nominal sum but with completion set for four years' time. In the meantime, James can keep the income. In four years time, when the property is far more valuable, the contract is completed. The CGT on the "sale" is nevertheless calculated based on today's low market value, not the higher value at completion. And if James survives seven years from completion, the property will be outside his taxable estate. He has effectively got the best of both worlds – he has minimised his CGT liability on the gift by taking advantage of today's low values whilst still retaining the income for a few years and ultimately achieving an IHT saving.
There is an upside to the downturn as there are significant tax savings to be made while asset values are low. If any of these ideas are suitable, you should seek further advice.