Rental Properties and Inheritance Tax – Have your cake and eat it

The changes to pension funds rules mean that pension assets can now be passed on through the generations totally free of Inheritance Tax. That fact, combined with tax free growth and tax relief on contributions mean that our advice to clients is take  full advantage now and route as much of your savings as possible through a pension plan.

However, to the extent that your wealth is tied up in residential property lets you will need to find another way to reduce your Inheritance Tax exposure. This is because your pension fund will not generally be able to invest in property.


So what are the options?

First of all you could consider giving away your rental property before your death to avoid the IHT charge. Making a straightforward gift of the properties would work if you survived for more than seven years, but there are some important caveats which often prevent such planning; for example:

  • an outright gift means you would lose control of the asset during your lifetime, and you may not want your beneficiaries to have immediate access to the property.
  • in addition, you would be unable to receive any more of the rental income generated. If you do you will be classed as having “reserved a benefit” in the property, meaning the full value of the property would be taxed on your estate on your death.

Fortunately, these two serious drawbacks can be overcome by use of trust planning; in particular by using the often overlooked provisions of s.102B Finance Act 1986.  This allows gifts of rented property to be made during your lifetime but provides a specific exemption from the “reservation of benefit” trap mentioned above.

Under the legislation you are allowed to give away a share in your rental property (i.e. not the entire property) while continuing to receive 100% of the income it generates, and retaining control of the underlying asset(s) as trustee.

So, if you are confident that you no longer need the capital value of your rental property but would like to retain the additional income it provides and keep control of the underlying assets during your lifetime you should consider making use of this provision.


Example – Janet and John are in their late 60s. They are in good health and have 3 children. They recently sold their business and retired. They invested some of the proceeds into 3 city centre flats, each worth £100,000 which are rented out to young professionals. They provide them with combined rents of £1800 per month which they are relying on to provide a substantial part of their retirement income. 

Their own home is worth £700,000. In addition they have savings of £285,000. So, their combined wealth stands at £1,285,000. By 2020 they will be entitled to IHT allowances of £1,000,000 leaving £285,000 to be taxed at 40% on their deaths. This would generate an IHT bill of £114,000.

They are reluctant to move house as they have long dreamt of enjoying their home in their retirement years. Although their savings are not producing much of a return they are reluctant to give much cash away as they would have nothing to fall back on in an emergency.

By making gifts of a 95% share in each of their 3 flats into trusts, which will ultimately benefit their children, but pay them 100% of the income during their lifetime, they can reduce their estate’s value by £285,000 wiping out their IHT liability completely while still retaining the full rental income for life.


Of course, you should take professional advice before embarking on planning of this nature to ensure that you can successfully claim these tax reliefs. Sutton McGrath Hartley is a multi-disciplinary firm of chartered accountants, financial advisers and lawyers offering comprehensive financial expertise for all business, personal and family interests. Our specialists can help with all aspects of tax and estate planning.

To discuss your requirements please contact Simon Turner on 0114 266 4432 or


Simon Turner, Partner at Sutton McGrath Hartley Financial Services
Simon Turner, Partner at Sutton McGrath Hartley Financial Services

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