Placing property in a trust can be a powerful estate planning tool, offering benefits such as asset protection, inheritance tax planning, and the flexibility to control how your assets are managed and distributed. However, this process is not without complexities, requiring a clear understanding of tax implications, trust types, and the legal framework surrounding property trusts.
In this guide, we’ll delve into the essentials of putting property into a trust, highlight its benefits, and discuss potential pitfalls so you can make an informed decision.
What Is a Property Trust?
A property trust is a legal arrangement in which ownership of a property is transferred to trustees who manage it for the benefit of designated beneficiaries. Trusts can be created during your lifetime (lifetime trusts) or as part of your will (will trusts) and activated upon your death.
Key participants in a trust include:
Settlor: The person creating the trust and transferring the property.
Trustees: Individuals or institutions responsible for managing the trust.
Beneficiaries: Those who benefit from the trust's assets.
Why Consider Putting Property Into a Trust?
Property trusts are commonly used for:
Inheritance tax planning: Reducing the taxable value of an estate.
Asset protection: Safeguarding assets from creditors or potential claims.
Avoiding probate: Simplifying the transfer of assets after death.
Providing for vulnerable individuals: Supporting minors or those lacking the capacity to manage their affairs.
Benefits of Placing Property in a Trust
1. Inheritance Tax (IHT) Planning
One of the most significant advantages of a trust is its potential to reduce inheritance tax liability.
If the property’s value (combined with gifts made in the last seven years) exceeds the IHT threshold of £325,000, a 20% tax applies when the property is transferred into the trust.
Surviving for seven years after the transfer removes the property from your estate, exempting it from the 40% inheritance tax.
However, gifts with reservation of benefit—such as continuing to live in a property transferred to a trust—will keep the property in your estate for IHT purposes.
2. Avoiding Probate
When a property is placed in a trust, it no longer forms part of the settlor’s estate. This means the property can be distributed or managed by the trustees without the need for probate, saving time and legal fees.
For example, trustees can continue renting out or selling a property immediately, whereas probate could delay these actions.
3. Flexibility for Trustees
With discretionary trusts, trustees have more control over how and when assets are distributed. This flexibility is particularly beneficial for managing a property portfolio or adapting to changing circumstances for beneficiaries, such as financial needs or personal situations.
4. Asset Protection
Trusts can shield assets from:
Claims during divorce or bankruptcy of beneficiaries.
Poor financial decisions by beneficiaries, especially minors or vulnerable individuals.
Tax Implications of Putting Property Into a Trust
Trusts come with various tax liabilities, which must be carefully considered:
Entry Charges:If the property’s value exceeds the IHT threshold, a 20% tax is due when transferring it into the trust.
Periodic Charges:Every 10 years, the trust is subject to a 6% charge on the value of its assets above the nil-rate band.
Exit Charges:Distributions of property or assets from the trust to beneficiaries may incur exit charges, depending on the property’s value and the trust’s history.
Income Tax on Rental Income:If the trust generates rental income, this income is taxable at the rates applicable to trusts, which can be higher than personal income tax rates.
Capital Gains Tax (CGT):If the property is sold, trustees may be liable for CGT on any increase in the property’s value since it was placed in the trust.
Types of Property Trusts
The type of trust you choose determines how the property is managed and taxed:
Bare Trusts:
The beneficiary owns the property outright and is responsible for all taxes.
Suitable for straightforward situations, such as gifting property to a child.
Discretionary Trusts:
Trustees decide how to manage and distribute the property.
Provides flexibility and asset protection but comes with higher tax rates.
Interest in Possession Trusts:
A specific beneficiary has the right to income from the trust but not the property itself.
Often used to provide a surviving spouse with a home while preserving the property for children.
Will Trusts:
Established upon death, allowing for the orderly transfer of property.
Frequently used to secure assets for minors or vulnerable beneficiaries.
Potential Challenges and Considerations
1. Complexity:
The tax calculations for trusts—particularly periodic and exit charges—can be intricate, requiring professional advice.
2. Cost:
Setting up and maintaining a trust involves legal, tax, and administrative fees. These costs may outweigh the benefits for smaller estates.
3. Restrictions:
Once property is placed in a trust, the settlor loses control over it. Trustees must act in accordance with the trust deed and may need court approval for significant decisions.
4. Double Taxation Risk:
In some cases, property transferred to a trust may face multiple tax charges, such as inheritance tax on the initial transfer and CGT upon sale.
How to Set Up a Property Trust
Seek Professional Advice:Consult a solicitor or tax advisor to understand your options and ensure compliance with UK trust laws.
Draft the Trust Deed:Outline the terms of the trust, including the role of trustees, the rights of beneficiaries, and the management of the property.
Transfer Ownership:Register the property transfer with HM Land Registry, ensuring it is legally owned by the trust.
Meet Ongoing Obligations:File annual tax returns, pay any relevant charges, and maintain accurate records of trust activities.
Conclusion
Placing property into a trust can be a strategic move to protect assets, reduce inheritance tax liability, and ensure a smooth transfer of wealth. However, it is not a one-size-fits-all solution. The complexities of trust law and tax implications make professional advice indispensable to avoid costly mistakes.
If you’re considering putting property in a trust, weigh the benefits against the costs, and consult a qualified advisor to ensure the arrangement aligns with your financial and personal goals.
Comments