Inheritance Tax – Using Market Losses to Mitigate IHT

Lower asset valuations might mean you can pass on assets more tax efficiently.

Corona virus has presented an unwelcome reminder of our own mortality, and as we know within the firm, have left many people scrambling to make sure their financial affairs are in order, including their potential inheritance tax (IHT liability).

As a reminder, everybody has an IHT allowance of £325,000, known as the nil rate band. Any assets other than the family home, over £325,000 threshold are subject to IHT of 40%. The value of the family home can be offset against the resident nil rate band, which for the 2020-2021 tax year is £175,000 per person, if it is left to direct descendants.

Transfers between married couples and civil partners, are not usually subject to IHT, so if the first partner dies leaving their estate to the other, no tax will be payable, and the remaining partner can use the deceased partner’s nil rate band when they die, effectively doubling the threshold for this to £650,000 and their resident nil rate band to £350,000.

But if you have assets over and above this, you will need to look at other ways of passing them on tax efficiently to your heirs.

Passing On Assets

Making a gift to your family and friends can be a good way to reduce the value of your estate for IHT purposes, and benefit your loved ones immediately.

You can give away £3000 worth of gifts each tax year without them being added to the value of your estate, and if you don’t use this annual exemption in a given tax year, you can carry it forward to the next year but for only one year.

If you die after seven years of gifting any asset of any value, no IHT is payable on it.

However if you die within 3 years of making a gift, and have used up your 3 year annual exemption, you pay IHT of 40%, if it is not covered by your IHT allowances. Gifts made between 3 and 7 years before your death, are taxed on a sliding scale called ‘Taper Relief’ if they do not fall within your IHT allowance.

When making a gift, you have to pay capital gains tax (CGT), on any profits you have made on the asset, in excess of your annual CGT allowance, which is £12,300 for the 2020-21 tax year.

As value of equity portfolios (share portfolio) have dropped substantially, now could be good time to make a gift, because your CGT liability is likely to be lower than it would have been at the start of the year.

If you die within 7 years and IHT is payable, tax is charged on the value of the asset at the point of gifting. So if the asset goes up in value after you have gifted it, the recipient effectively benefits from a lower tax rate.

If when you die the value of the gift is lower than at the time when it was given, the recipient can claim falling value relief. This means that IHT is charged according to the lower rate value.

If you have made gains on stocks that you have held for along, now might be a good time to offset gains against loses, and the rest against your annual CGT allowance.

If part of your share portfolio was acquired six months ago at the height of the market, and its value has now fallen 30%, you could crystallise the capital losses now by off setting them against gains on assets that you plan to gift.

If you incur CGT on the gifted assets, and die within 3 years of gifting them, they could also incur IHT, and this might amount to more than what your or your heir’s might have paid, if you would have kept the assets within your estate.

If you want to pass on assets, but do not want the beneficiaries to have control over them at that point, you could put them into a trust. If the disposal incurs CGT when transferred to a trust, you can defer it.

Trusts can be set up for children, with parents as the trustees and children as the beneficiaries.

A trust correctly set up, does not form part of its beneficiary’s estate in cases where they are on state benefits, for example if they are disabled, they continue to receive them. You can put £325,000 per person into a trust every seven years,  without incurring IHT, as per your nil rate band, but any assets over the value will trigger tax of 20% at entry. People with large estates can set up a family company as this does not incur IHT, but that is for a broader discussion.

If you require help in connection with any of these matters, please do not hesitate to contact us.