The COVID-19 crisis has badly impacted asset values, particularly share prices and property. If you have been affected then now may actually be a good time to consider tax-efficient estate planning to provide financial support to extended family members. In particular, it could be the ideal time to make gifts to your children, grandchildren, unmarried partner or other intended heirs.
What are the capital gains tax implications of making gifts?
Most outright gifts escape inheritance tax (IHT) if the donor survives seven years (with a reduction on a sliding scale if the donor survives between three and seven years from the date of the gift). But what often deters potential donors is that a gift is treated as a disposal at market value for capital gains tax (CGT). So if you make a gift of shares to your children, and the value of the shares is higher than your original acquisition cost, then you need to pay CGT on the difference at 20%; even though you don't actually receive any sale proceeds. This can be a real barrier to making gifts. However, if your share or property portfolio is no longer standing at a gain following recent market falls, a gift now would not result in CGT even if values recover soon after.
What are the inheritance tax implications of making gifts during my lifetime?
An advantage in making gifts when asset values are low is that if the donor fails to survive seven years, although IHT will be payable at up to 40%, it will only be payable on the value of the asset as calculated at the date of the gift. At today's values, this could be a lot lower than the future value at the date of the donor's death and the overall IHT liability will be lower than if the asset had been retained until the donor's death.
Can I set losses against gains?
If you would like to make gifts now but your assets are still showing gains, and you wish to reduce any CGT on the gifts, consider whether you may have carried forward losses from the sale of other assets in the past. Those losses can generally be set against a gain on a gift so that no CGT is actually payable on the gift. Alternatively, if you own specific shares or property standing at a loss and others standing at a gain, if you were to give both away then the aggregate position may be no gain overall. You may therefore avoid any CGT on the aggregate gift while still managing to give away specific assets showing a gain.
Is gifting appropriate for the elderly?
Older people are sometimes reluctant to make gifts even if they don't need the assets. That can be for two reasons. First, they may not be confident of surviving seven years. Secondly, if they retain assets until their eventual death then any gains that accrued during their lifetime are exempt from tax and effectively wiped out. Instead their heirs inherit the assets with an acquisition cost (for CGT purposes) equal to their market value at the date of death. Many older donors are reluctant to give away assets in later life and lose the benefit of this CGT market value uplift, particularly if making the gift during their lifetime will trigger a CGT charge, and they do not feel confident about surviving the necessary seven years for IHT purposes. But lower asset values may mitigate both of these concerns. Consider, for example, a gift of shares by an elderly widow to her daughter.
First, where share prices are much lower now, the shares may no longer be standing at a gain and so there may be no CGT payable on the gift (as explained above). But even if there is a gain, so that some CGT will be payable on the gift, it may still be a worthwhile approach. This is because if share prices increase again in the short to medium term, and even if the mother fails to survive seven years so that IHT is payable at 40% on the gifted shares, IHT will only be payable on the value of the shares at the date of the gift, which may be considerably lower than their value at the date of death. And although the CGT base cost uplift will not be available, so the daughter will ultimately be subject to CGT on the gain in value between the date of the gift and her mother's death, that gain will only be taxable when the daughter eventually sells the shares. Importantly, at today's rates the daughter would pay CGT on that gain at just 20% whereas the IHT saved on that gain will have been 40%. The daughter may even have her own capital losses to reduce the taxable gain when she eventually sells the shares. She could also sell the shares in stages over a number of years, using her annual CGT allowance to offset each year's gain. Alternatively she may live abroad and not be subject to UK CGT at all.
Why should I make these changes now?
Although assets values may have fallen greatly since the start of the COVID-19 crisis, this will hopefully be a temporary reduction. If you feel confident that is the case then now may be a sensible time to consider a tax-efficient gifting programme which could ultimately mitigate inheritance tax for your family whilst also reducing any CGT liability.
If you would like to discuss any of the estate planning strategies set out in this Briefing Note then please contact Andrew Goldstone, Head of Tax and Wealth Planning or your usual Mishcon de Reya contact.