Key points at a glance
Estate agents and conveyancers in the UK usually advise married couples to buy homes as beneficial joint tenants. This means if one of them dies, the other inherits the home automatically and without the complications of probate. However, if one of the couple is a US person, joint tenancies can create numerous complex and unwelcome tax consequences. The examples below highlight why US persons should always take US tax advice before buying property in the UK.
US federal income tax on the gain on sale
If a married couple has bought their home as joint tenants 50% of any gain realised when the property is sold will be attributed to the US spouse; but only US$250,000 of that amount will be tax-exempt for main residence purposes. This is in stark contrast to the UK tax position, where the entire gain on sale of a principal private residence is generally exempt from UK capital gains tax. So although there’s no UK tax payable when a home is sold, there may be substantial US tax payable on the gain.
Most US spouses who find themselves in this position only realise they have a problem in the run-up to selling the property. Attempting to restructure ownership at that late stage might not result in the intended consequences. It’s much better to minimise potential US exposure on the gain by planning for this situation well in advance but care is needed if restructuring is contemplated even if a sale transaction is not planned.
US estate tax + UK inheritance tax exposure
When a US spouse dies owning jointly owned property, the starting point for US estate tax purposes will be to attribute 100% of the property’s value to them. It’s up to the executors to establish that the non-US owner contributed to the purchase and/or to mortgage payments, before working out their share of the equity.
Depending on the equity split (and the other assets in the estate), significant US estate tax could apply on the American’s death; while the property is likely to pass free of inheritance tax in the UK. Then, when the second spouse dies, UK inheritance tax would be payable on the full value of the property (with no credit for the US estate tax already paid). Double taxation, in other words.
Care needed if restructuring planned
These issues largely go away if all or a significant proportion of the property is held in the name of the non-US person. However, if the couple has an existing property, US gift tax could be triggered if the US spouse simply gifts the property to the non-US spouse. On the purchase of a new property the couple might decide that it be bought in the non-US spouse’s name but gift tax issues might similarly arise if the US spouse gifts or lends the money to the non-US spouse to buy the property.
If a US person makes gifts to his non-US citizen spouse, he risks eating into his lifetime tax exemption (if the annual limit – currently of US$159,000 is exceeded). That would be inefficient. Once the lifetime allowance is exhausted, it’s gone. The property has only passed across a generation. And it’s still in the UK inheritance tax net (where the exemption threshold is much lower than in the US).
Why owning property through a company seldom makes sense
Buying property through a company has become increasingly inefficient for a number of reasons. There’s no principal private residence relief on homes owned through companies, so tax is payable on any gain realised on a sale. There’s an annual charge on ‘enveloped dwellings’. Further there’s 15% stamp duty land tax payable on purchase, along with a ‘benefit in kind’ charge if a company director (or someone treated as a director ) is deemed to be receiving a benefit from the company (living in the property rent free, for example). Significantly for those neither domiciled nor deemed domiciled in the UK, with effect from April 2017, owning property through a non-UK company will provide no protection against UK inheritance tax.
For the many people who did buy through companies, a key challenge now is how to ‘de-envelop’ the property and extracting the value without triggering UK capital gains tax and possibly stamp duty land tax (if there is a mortgage on the property).
Buying as tenants in common
The preference is usually to buy as tenants in common (instead of joint tenants), giving careful consideration to the economic contribution made by each spouse. On death, each person’s share will pass in accordance with their will into a trust for the survivor and other family members.
If the first person to die is a US person (with total assets exceeding US$11.7m), then any assets passing to their non-US citizen spouse will not qualify for a marital deduction for US purposes. That situation can be avoided, however, if the will is drafted to provide for a ‘Qualified Domestic Trust’ (QDOT) election in relation to that portion of the estate.
Providing liquidity for inheritance tax
UK inheritance tax on real estate must generally be paid within 10 years of a death. The alternative is to take out insurance that will provide lump-sum liquidity to pay the tax when it’s due. Depending on factors including the age of the insured, and how long they’re likely to be living in the UK, this can be cheaper than setting up a more complex structure. Life insurance should be held through a trust. This will ensure the proceeds are paid to the trustees and not into the deceased person’s estate. US owners will avoid complications by transferring funds to the trustees, who then buy the policy themselves. Care needs to be taken to ensure that beneficiaries are given certain powers over the trust so that annual premiums do not reduced gift and estate tax thresholds.
We have highlighted the extent and complexity of issues arising for US/UK couples that invest in UK real estate. Holistic estate planning is an essential step, with the combined effects of US and UK tax and regulation taken into account at every stage. Without it, there is a very real risk that the estate will be taxed twice – once in the UK and once in the US.