It’s something that frustrates, enrages and outrages in equal measure: inheritance taxes on the family home. For many people, having paid down a mortgage with after-tax income throughout their lives, leaving a legacy of a substantial tax bill for their children feels akin to double taxation.
And yet, despite the outrage, most of us are shockingly ignorant about just how Ireland’s inheritance tax regime works. A recent survey from Irish Life, for example, revealed that while a quarter of over 65-year-olds expect to leave estates of more than €500,000, half of adults think their family home is exempt from inheritance tax.
Unfortunately, for many families leaving homes valued at Dublin prices, having to write a large cheque to the Revenue Commissioners in the aftermath of a death can come as an unwelcome, and sometimes unaffordable, surprise.
So what do you need to know about death taxes on the family home in Ireland?
How to inherit – tax free
It is possible to transfer property to someone else – without incurring a tax bill – in a number of ways. Firstly, inheritance tax doesn’t apply if the value of the property falls within the tax-free thresholds.
“For the vast majority of people that would be the case, particularly outside Dublin, where properties wouldn’t hit the exempt thresholds,” says Darragh McCarthy, head of private client services at EY.*
This means, for example, that a property worth €400,000, shared by two children, won’t incur a tax bill, as the transfer to each is within the parent-to-child thresholds (€310,000).
Similarly, if five nieces and nephews inherit a house worth €162,500, no liability will apply, as it’s again within the thresholds (€32,500), while if you inherit a share in a property from someone who isn’t related to you, and it isn’t worth more than €16,250, again there will be no bill.
Should you go over these thresholds, however, tax at a rate of 33 per cent will arise – even on the family home. A property worth €600,000 inherited by one child will incur a tax bill of €95,700.
“Although many people intend to leave significant amounts to their children and grandchildren when they die, most of them are unaware that those family members could be liable for a very substantial tax bill on those inheritances,” says Kate Connor, protection manager with Irish Life.
For example, a property worth €600,000 inherited by one child will incur a tax bill of €95,700 (33 per cent of €600,000-€310,000), while a property worth €100,000 left by someone with whom you have no recognisable relationship with will incur a bill of €27,637 (33 per cent of €100,000-€16,250).
If you’re married or in a civil partnership, no tax is liable on asset transfers, which means that a family home or investment property can be transferred with no tax liabilities.
Remember, however, that it only refers to legally recognised partnerships; common law partnerships are not recognised by the Revenue Commissioners, which means that even if a couple have been together for 60 years, should one of them die, there will probably be a tax bill to settle. Yes, their life insurance may in fact pay off the mortgage on the property, but the surviving spouse will still incur a tax bill on the transfer of this property to their estate.
Any special cases?
Another way of passing on a property tax-free is to avail of the so-called dwelling house exemption – but its use has been restricted.
Used by thousands of people to pass on properties to their children, free of tax, the dwelling home relief was once a very popular tax exemption. However, its use was tightened significantly from December 25th, 2016.
“In practice it doesn’t have wide application,” says McCarthy. “I wouldn’t expect to see it much into the future.”
But it might still be of use to some.
The key criteria that now allow someone to inherit a property tax-free is that the property must have been the “only or main home” of the person who died. In addition, and this is where it gets tricky, is that the person inheriting must now have also lived in this property as their main residence for the three years prior to the transfer. Other requirements mean that to inherit tax-free, they cannot have an interest in any other property, and they must also stay in the house for six years after the transfer.
But there are some ways of getting around some of these points.
First of all, the three-year rule as well as staying in the property for six years subsequently does not apply where people are aged over 65.
Moreover, people can avoid this requirement in a number of ways. Firstly, if they sell the property they’ve inherited and invest all of the proceeds in another property, the relief stands. It also stands if the successor has to move either somewhere else in Ireland, or abroad, for work reasons.
Another quirk is that even if the owner of the property goes into a nursing home in the final years of their life, the person inheriting can still avail of the relief if they were living in the house.
Wait until death?
For many families, a discussion about what happens in the event of the parents’ death never really happens until after the fact.
Others, however, are more proactive, and may wish to downsize – particularly at a time of a housing crisis when children may be eyeing up enviously their parents’ home.
But according to McCarthy, while each case will be different, transferring the family home during your lifetime can be more expensive than waiting until your death. This is because Irish stamp duty applies to lifetime gifts to property, which would not apply to inheritances on death. This means, for example, that the transfer of a house worth €500,000 would incur stamp duty of €5,000, while a property worth €2 million would incur duty of €40,000 – enough perhaps to make you think twice. And the rate of duty on investment properties is 6 per cent.
And of course, if the parents pay the stamp duty on behalf of a child, this could give rise to a capital acquisitions tax (CAT) liability.
One way to deal with the transfer of investment properties would be to house them in a company structure, as the company cash could then potentially be used to settle CAT charges. As a related point, McCarthy advises families at the early stage of property investment to consider co-investing, as in the event of the deaths of the parents, the children’s CAT liabilities will be restricted to the deceased’s share rather than the entire portfolio.
There can definitely be a sting in the tail for individuals who have foreign property, as they can often completely ignore foreign estate issues
And be careful also of other implications when considering a transfer during your lifetime. While a parent can sell a home to a child at a discounted price, the difference between the sale price and the market value will be considered to be a “gift” by the Revenue Commissioners, and will thus attract CAT if the child has already exhausted their tax-free threshold.
A nifty way to approach this, says McCarthy, is to make use of the €3,000 annual small gifts exemption (unchanged since 2003, it should be noted, and thus ripe for an increase).
If the property exchange was funded via a “loan” from the parent, for example, the parents could then, potentially, pay off the loan to the order of €6,000 a year without a CAT bill arising – of course, depending on the size of the shortfall, this could take some time to pay off in this manner.
Another consideration is if capital gains tax (CGT) and CAT both arise, you can use the CGT you have paid as a credit against the CAT. In the context of the family home, this is unlikely to apply, as it won’t be subject to CGT, but may be appropriate for investment properties.
If so, McCarthy warns that the “sequence” of transfer/sale of assets is very important to maximise tax efficiency.
For example, in such cases he suggests that it can be more efficient to transfer the family home in the first instance and use up the thresholds, and then subsequent gifts that would give rise to CGT would be made after these thresholds are exhausted.
Finally, we’ve spoken so far of Irish-based properties – but property abroad can cause further challenges. Not something people think much about, perhaps, when buying a place in the sun.
“There can definitely be a sting in the tail for individuals who have foreign property, as they can often completely ignore foreign estate issues,” says McCarthy.
Settling a bill
Given people’s general ignorance of potential inheritance tax liabilities, it’s helpful to learn that the Revenue Commissioners are willing to receive CAT bills in instalments. It’s less helpful, however, to learn that they’ll charge you an arm and a leg – 8 per cent interest – on such an agreement.
“This is something we’d like to see reduced,” says McCarthy, although he adds that “at least it prevents a forced-sale scenario”.
You could also consider starting to save for any potential CAT bills now, as the Revenue still allows two tax-efficient savings schemes to enable you to do this.
Section 72 policies, for example, cover the cost of settling an inheritance tax bill in the event of your death and, crucially, don’t incur a tax liability themselves. They allow you to save towards a life assurance policy, with the proceeds going to pay off an expected inheritance tax bill. The key advantage is that the proceeds of the policy is not subject to CAT. However, there are some downsides – they’re expensive (expect to pay about €218 a month for €100,000 of cover); they need careful planning to ensure they match the tax owed; they have no cash-in value; and they need to be taken out early to be worthwhile.
You could also consider a section 73 savings plan. Again Revenue-approved, this allows you to gift the proceeds of this plan to your estate to meet any tax bills – and again, this gift is not liable to inheritance tax. Moreover, you can choose to keep the funds yourself if you so wish. However, they again need careful thought and can be expensive.
THE TAX-FREE THRESHOLDS
Between spouses All tax free
Group A (parent to child) €310,000
Group B (relatives such as nieces and nephews) €32,500
Group C (stranger) €16,250
Fiona Reddan, irishtimes.ie