Potential pitfalls when inheriting rental properties

Property118

Potential pitfalls when inheriting rental properties

You have a limited company owning rental properties and are due to inherit rental properties from your parents? Read on.

How your parents structure their will should be influenced by your future plans for those properties. Get it wrong and you could face an unexpected tax bill.

The starting point is simple:

Do you plan to sell the inherited properties, or keep them long term?

If the plan is to sell, it will often make sense for you (and any siblings) to inherit the properties personally.

Why?

Inherited property is generally rebased to market value at the date of death, so if you sell shortly afterwards there may be little or no CGT to pay personally.

That can leave you with tax-efficient sale proceeds available for reinvestment.

For example, you could introduce the proceeds into your limited company as a director’s loan, allowing future tax-free withdrawals of those funds.

Yes, this route may involve selling costs and then buying costs again (legal fees, mortgage fees and SDLT/LTT/LBTT on replacement purchases), but the tax position can still be attractive.

The decision should depend on practical investment considerations:

• Do the inherited properties fit your investment strategy?
• Are they in the right location?
• Do they generate the yield you want?
• Would you rather recycle capital into different assets?

But what if the plan is to keep the properties long term?

This is where planning becomes important.

If you inherit the properties into your limited company, either directed by the will or via a deed of variation, you are effectively moving value into the company.

That value increases the company’s shareholding value and, at some point in the future, extracting that value personally is likely to involve tax.

In simple terms:

Inherit personally + sell = potentially tax-free capital available to reinvest

Inherit via company + hold long term = value stays within the company structure

If the company sells an inherited property, there may be little or no corporation tax on historic growth up to the inheritance date because the property is inherited at market value. However, extracting sale proceeds personally may trigger dividend tax (or another form of extraction tax).

By contrast, if you inherit personally, sell, and lend the proceeds to your company, you create a director’s loan account, which can generally be drawn back tax free in the future.

That said, if your intention is genuinely long-term hold, it may still be preferable for the company to inherit the property directly.

Where siblings are involved, planning becomes more important

Jointly inheriting one property can create complications.

Where possible, it is often cleaner to split assets so siblings inherit separate properties rather than co-owning each one.

Another option may be a jointly owned company structure. For example, a subsidiary company to your investment company could be established with family member shareholdings and this company could inherit the properties.

Timing and will planning matters

One trap to avoid is partial inheritance on first death.

For example, one parent leaving their share of a property directly to a child on first death can create complexity. It may not be possible to refinance the properties.

In many cases, it is simpler for the surviving spouse to inherit first, with the generational transfer happening on second death.

Be careful relying on a deed of variation after death

I often see families trying to “fix” matters after death using a deed of variation to divert inherited property from an individual beneficiary to a limited company.

This can work smoothly for unencumbered properties.

However, where mortgages are involved, additional tax issues can arise.

In broad terms, if a company effectively takes on mortgage debt connected with the inherited property, SDLT/LTT/LBTT can potentially arise because the mortgage may be treated as consideration.

This can catch families out.

There are specific reliefs and exemptions available for inherited property in certain circumstances, but the position can change depending on whether the property is inherited directly or diverted through a deed of variation.

The drafting of the will is also important.

Normally, a mortgage secured on a property passes with the inheritance and the beneficiary refinances if needed.

However, if the intention is for the estate to redeem the mortgage before the property passes, the will should expressly provide for this (“contrary intention” wording). Of course, the estate must have sufficient liquid assets available.

The key point?

Do not wait until after death to think about this.

Proactive planning can help ensure:

• the inheritance ends up where you actually want it,
• unnecessary SDLT/LTT/LBTT is avoided,
• future extraction taxes are minimised,
• and inheritance tax planning opportunities are not missed.

The right answer depends on your long-term strategy, family circumstances and whether the properties are intended for sale or long-term hold.

LEARN MORE

A conversation worth having?

If you are weighing up your own strategy, it is worth stepping back and reviewing how everything fits together.

These conversations are typically most useful for landlords with established portfolios and relatively modest borrowing who are beginning to think about how their assets will serve them over the next phase.

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