Recently, a number people have been asking me if they could set up a trust, primarily because in their mind it seems like others do it and subsequently pay less tax. This rather outdated vision of a trust comes in all probability from the 80's and 90's when they were somewhat more tax efficient and hence used as tax avoidance. However, HMRC shut down many of these loopholes in the early 2000's.
In reality, the reasons for setting up a trust are usually about protecting assets and are part of inheritance tax planning (when used correctly).
To set up a trust you will need a trust deed. A trust is a legal entity, and it needs to be set up by a lawyer with the appropriate skills. By creating a trust and placing the asset into the trust you have the legal owners of the asset, the trustees, and the beneficial owners, the beneficiaries who have the beneficial interest of the asset. Revoking a trust is not easy so you really must make sure it is what you want prior to going ahead.
There are going to be taxes when it comes to putting an asset into a trust - lets look at a scenario. Your parent is going to move into a care home, as they find that living alone since the death of your other parent is too much. There is enough accessible funds for their care. So they want to place their house into trust for the benefit of you and your future generations.
Setting up a trust in your lifetime is almost always going to make the trust a discretionary trust and settling an asset into the trust is a chargeable lifetime transfer for inheritance tax (IHT). This means that if the property is valued over the nil rate bad of £325k then the balance of the transfer is taxed at 20% for lifetime IHT. If your parent dies within 7 years then the full value enters the estate and the 20% of tax already paid is deducted of the new calculated IHT (at 40% on death).
Settling an asset into a trust is a disposal for capital gains tax purposes (CGT); in this scenario the family home was your parent's principal private residence so there is no CGT to be paid on settling the asset. There are various reliefs for other disposals and the big one is that if IHT has been due on the transfer then you can claim a relief for CGT which sees the asset transferred at the value the settlor bought it for.
However, IHT doesn't stop there. A discretionary trust is required to submit 10 year principal charges for IHT. This revalues the trust and then using a complex formula a value of IHT is paid at the 10 year anniversary. This can be no more than 6% of the value of the trust. When a trustee decides that some capital can be paid to a beneficiary then there is an IHT exit charge. Again this is a complex calculation and can be no more than 6% of the value of the asset being given.
If a trust has income from investments, rents or interest then it must register for tax and pay annual income tax. A trust does not benefit from a personal allowance and has only a £500 allowance at the basic rate of tax and the rest of the income is charged at 45% of tax.
If a trust sells an asset the trust must pay CGT. For a trust there is an annual exemption, this is half of the exemption given to an individual. CGT rates are the same as for an individual but always at the higher rate.
There is a lot of tax cost and admin around setting up and running a trust. You should ask yourself whether this is really the best solution for what you want to achieve with gifting of assets. When you want to start thinking about how to gift or pass wealth on, then get in touch and have a review with me. We can look at all the options and the cash outlay associated.
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