Inheritance Tax vs Capital Gains Tax – are trusts always the answer?

In the world of tax planning, the wider media can portray trusts as the answer. Stories about how trusts can save tax and preserve inheritance are wonderful filler for the Sunday newspapers. Trusts do have some very significant positives, particularly around protecting wealth for future generations – however they have limitations if their benefits are considered alongside the consequent increased tax liabilities in certain situations.

Everyone is limited as to the value of assets which can be put into trust without incurring an immediate inheritance tax charge. Provided that you have not made any gifts besides those to your spouse and to charities within the last seven years, then this is likely to be £325,000 for an individual or £650,000 if a married couple make a joint settlement into trust.  This is known as your “nil rate band”.

One benefit of settling property on trust is that the asset concerned may no longer form part of the estate for inheritance tax purposes, so long as the individual surrenders any benefit that they may have taken from the asset, and that the individual survives the gift by seven years. For a married couple who settle £650,000 into trust, successful gifting into trust confers a potential saving of £260,000 in Inheritance Tax, inheritance tax being charged at 40%.

Many individuals find themselves in a situation where the assets they wish to settle on trust stand at a significant capital gain, meaning that the asset stands at a higher value than the cost at which they acquired it. Assets such as residential properties besides one’s own home and shares in family property companies can frequently stand at large capital gains. In such instances, an individual settling property onto trust can “hold over” the gain into the trust, using holdover relief, so that the trust acquires the asset at the same base cost, thus deferring capital gains tax.

However, one disadvantage of this planning from a tax perspective is the loss of the uplift on death for capital gains tax purposes. On death, any capital gains that may have been held by an individual are wiped out, and any beneficiary inherits property with a base cost of the asset’s value as at the deceased’s date of death. If an individual had settled an asset on trust prior to death, notwithstanding it being brought into account for inheritance tax purposes should the gift have taken place less than seven years before death, the gain on the asset held in the trust would be taxable to capital gains tax on any future disposal of the asset (through transfer to a beneficiary, sale or other means – albeit in some circumstances holdover relief can be claimed again) at 28% for residential property and 20% for other types of assets. Further, a trust only has half of the annual exemption for capital gains that an individual has – currently £6,150 (2022/23) – so an even greater proportion of the gain will be chargeable for capital gains tax than an individual disposing of the asset.

Sometimes therefore there are limited opportunities to mitigate tax entirely. Instead, it may be worthwhile to consult your trusted tax professional to see how your inheritance tax and capital gains tax liabilities can be managed concurrently and efficiently.

By Celia Gould, Trainee Solicitor