Where there is a will there is a way to limit tax

Bequeathing a house or business need not lead to a huge bill from the taxman, writes Laura Slattery

Inheritance tax used to be something that only the embarrassingly well-off had to bother thinking about and only their equally comfortable offspring had to pay.

But with property prices escalating over the past decade and many equity-rich homeowners playing the buy-to-let game, the group of people who will potentially see the value of their inheritances slashed by tax is now larger than ever before.

Inheritance and gift tax are collectively more properly known as capital acquisition tax (CAT) and are charged at a rate of 20 per cent.

People can inherit or receive as a gift a certain amount without any tax being payable and these thresholds depend on the relationship between the person giving and receiving the inheritance (see panel).

While the tax-free thresholds increase every year in line with the Consumer Price Index, they haven't kept pace with property inflation.

"Ten years ago, inheritance tax was for rich people," says Ned Gladney, tax director at accountancy firm OSK.

"But because they haven't increased the exemption limits in line with property inflation, a lot of people will have a second property or a property portfolio worth more than the limits," he explains.

"If they have more than one child, they can spread it around, but if there is only one child, he or she could be hit with a tax bill."

Ways to minimise CAT are thus climbing the "things to do" financial affairs list for homeowners who want their children, relatives or other beneficiaries to enjoy the proceeds of their estate tax-free.

"One of the things driving people on this is the fact that the exemption limit on assets passed to your kids is around €466,000, but the average house price in Dublin is expected to be €350,000 in 2005," Gladney says.

People who have embraced the property investment craze over the years should therefore consider "gifting" investment properties to their children while they are still alive, rather than leaving matters until after they die, by which time average property prices will presumably have climbed further.

A property with a value of €450,000 currently has no inheritance tax liability if it is passed to a child.

But if prices rise by a modest 10 per cent and just one child inherits, the asset will cross the CAT thresholds and the child will face an immediate tax bill of 20 per cent of €33,275 (€500,000-€466,725), or €6,655. Parents whose children are under the age of 18 at the time they choose to transfer assets to their name for tax-planning purposes will have to set up a trust, with the children's control restricted until they are deemed mature enough.

However, the expense of holding assets in trust for long periods of time means that the potential tax bill they are trying to avoid would have to be quite high.

Even where adult children are the eventual intended beneficiaries, not every parent will want to pass on control of their assets just for the sake of tax efficiency.

After all, some may find it difficult to care about exactly how the intricacies of the tax system will kick into gear once they have passed on.

And there is no question of twentysomething children who have yet to fly the nest being forced to sell the home in which they live in order to settle some monstrous CAT liability.

Dwelling relief is available to any recipient who lives in the property as his or her only or main residence for three years prior to the date of the gift of inheritance and six years after.

The condition requiring the recipient to live in the property for six years does not apply to beneficiaries over the age of 55 and is waived where people need to relocate for employment or health reasons.

Assets can also pass between spouses tax-free, although when the second of the two partners dies, their combined wealth will pass down to the next generation, eventually triggering a potential tax bill.

"Many people just don't address the issue in the first instance," says Anthony Casey of Noone Casey accountants.

"The first point is that everyone should have a will. If they don't, they have no control over the distribution of their assets," says Casey.

Those who get over the morbidity of the process and take the prudent step of drawing up a will can choose to split their estate so that the overall amount of tax payable by their survivors is reduced.

In other words, they could choose to leave children, grandchildren, brothers, sisters and other relatives a share of the estate worth slightly less than the tax-free threshold that applies to them.

But there is little point in chasing tax efficiency at the expense of your wishes as to who your beneficiaries should be.

In turn, a surviving child would probably much prefer to take the hit and pay tax on the entire estate than receive a smaller, tax-free share and see the rest of the estate distributed among long-lost relatives.

Casey recommends that people should review their wills after buy-to-let dabbles or other changes in their circumstances.

The merits of making tax-efficient gifts and the appropriate timing will vary from family to family, he adds.

While property is usually the main asset passed on through a will, in some cases family-owned businesses can complicate matters.

From a tax perspective, however, the issue of succession planning for typical small family businesses is not as serious as it used to be, according to Brendan Lane, a partner specialising in family businesses at Grant Thornton.

"You can now get 90 per cent CAT relief on a family business. So if your business is worth €4 million, you would pay CAT on just 10 per cent of that or €400,000.

"At that point, you would be under the exemption limits, even if you were passing on the business to just one child," says Lane.

This relief has been in place since 1994.

But family business owners sometimes overlook the fact that not all business assets qualify, adds Lane.

"Non-trading assets like surplus cash or property that is not used in the business - property that is not the business premises - do not qualify. If they were overlooked, there could be a CAT liability."

The relief can be clawed back if the beneficiaries decide to sell up and stop trading within six years, although no clawback applies if the business goes bankrupt or becomes insolvent during this time.

Estate planning can be a complex business, notes Casey, and people with even modest assets to their name should seek both legal and taxation advice.