Discretionary Trust UK — Property in Trusts, IHT Ten-Year Charges, Exit Charges, and CGT Hold-Over Relief

What Is a Discretionary Trust for Property?

A discretionary trust is a trust in which: (a) the trustees hold legal title to the property; (b) the trustees have discretion about how to apply the trust income and capital among a class of potential beneficiaries — no individual beneficiary has a fixed right to any income or capital; (c) the class of beneficiaries is specified in the trust deed (e.g. 'my children and remoter issue') but the allocation among them is entirely at the trustees' discretion. Common reasons landlords use discretionary trusts for property: (i) protecting rental property from relationship breakdown by a child (property in trust is not the child's asset); (ii) providing a flexible vehicle for directing income to lower-rate taxpayer beneficiaries over time; (iii) IHT planning — removing the property from the settlor's estate after the 7-year gift rule (though the relevant property regime imposes its own charges); (iv) protecting assets for beneficiaries with capacity issues or who are vulnerable to creditors; (v) holding commercial property for a family business in a trust structure. Property types settled into discretionary trusts: buy-to-let residential properties; commercial properties; development land; portfolios of properties transferred as a gift to fund a trust.

• Trustee discretion: trustees decide which beneficiaries receive income and capital and when — no beneficiary has a fixed entitlement
• Settlor: the person who creates the trust and settles property into it; the settlor is excluded from benefiting after the trust is created (or the trust is a gift with reservation for IHT)
• Beneficiary class: defined in the trust deed (e.g. children and grandchildren); the trustees allocate among the class at their discretion
• Asset protection: discretionary trust property is not the beneficiary's asset — protected from divorce, bankruptcy, and creditors while in trust
• Relevant property regime: discretionary trusts are subject to IHT ten-year charges and exit charges — unlike bare trusts which are transparent

IHT — Relevant Property Regime: Ten-Year and Exit Charges

Property in a discretionary trust is subject to the IHT relevant property regime under IHTA 1984 ss.58-85: (a) Entry charge: if the value settled into the trust exceeds the settlor's available nil rate band (£325,000 in 2024/25; frozen until 2030), an immediate IHT charge at 20% arises on the excess (half the death rate of 40%); (b) Ten-year anniversary charge: every ten years after the creation of the trust, the trustees pay IHT at up to 6% of the value of the relevant property in the trust; the maximum rate is 6% (30% of the 20% lifetime rate) and is reduced proportionally if the trust is less than 10 years old at the anniversary and if the nil rate band was used; for many residential property trusts, the effective charge is 3-5% per decade; (c) Exit charge: when property leaves the trust (by distribution to a beneficiary or by other means), an exit charge is calculated proportionally to the next ten-year charge — expressed as a fraction of the ten-year rate multiplied by a time factor; (d) Reporting: the trustees must file an IHT return (Form IHT100) on the ten-year anniversary and on each exit; professional advice on the valuation of trust property at each anniversary is essential; (e) Agricultural and Business Property Relief: APR or BPR may be available to reduce or eliminate the ten-year and exit charges on qualifying agricultural or business property held in the trust — providing up to 100% relief from the relevant property charge.

• Entry charge: IHT at 20% on value settled above the available nil rate band (£325,000 in 2024/25) — immediate upfront cost if the trust is large
• Ten-year charge: up to 6% of the trust's value on each ten-year anniversary — for a £1M property trust, potentially £60,000 every 10 years
• Exit charge: payable when property or cash leaves the trust; proportional to the next ten-year anniversary charge and the time elapsed
• IHT100 filing: trustees must file IHT100 on each ten-year anniversary and exit event — professional valuation of trust property is required
• APR/BPR: agricultural or business property held in the relevant property trust may qualify for 100% relief from ten-year and exit charges — dramatically reduces the ongoing cost

CGT on Settling and Distributing Property

Capital Gains Tax applies to property settled into and distributed from a discretionary trust: (a) Settling property into the trust — hold-over relief: where a property is settled into a discretionary trust by gift (no consideration), CGT hold-over relief under TCGA 1992 s.260 is available — the gain is 'held over' rather than crystallising immediately; the trustees take the property at the settlor's original base cost; no CGT is payable at the point of settlement; s.260 hold-over relief is automatically available for lifetime transfers into discretionary trusts; (b) Trustees' CGT: when the trustees dispose of trust property (e.g. by sale or distribution to a beneficiary), a CGT charge arises at the trust's CGT rate — 18% (basic rate band at trust level; unused) or 24% (higher rate for residential property); trustees' annual exempt amount is £1,500 from 2024/25 (reduced from £6,000 in 2022/23); (c) Hold-over relief on distribution: when the trustees transfer property to a beneficiary, s.260 hold-over relief is again available — the gain crystallised in the trustees' hands can be held over, passing the liability to the beneficiary; the beneficiary takes the property at the trustees' historic base cost; (d) Settlor-interested trusts: if the settlor (or their spouse) is a potential beneficiary, the trust is a 'settlor-interested trust'; s.260 hold-over relief is NOT available and gains are taxed on the settlor directly — this is a critical trap; (e) Principal Private Residence Relief: PRR is not available to the trustees on disposal of trust property (even if a beneficiary lives in it) unless a specific election is made and the beneficiary occupies under a formal arrangement.

• s.260 hold-over relief: available on settlement into a discretionary trust — no CGT on entry; trustees take property at settlor's base cost
• Trustees' CGT: charged at trust rates (24% residential property) on disposal; trustees' annual exempt amount is only £1,500 from 2024/25
• Hold-over on distribution: s.260 relief also available on distribution from trust to beneficiary — gain held over; beneficiary inherits historic base cost
• Settlor-interested trap: if the settlor or spouse is a beneficiary, s.260 hold-over relief is NOT available — gains taxed on the settlor directly; avoid this structure
• PRR in trust: not automatically available; requires specific election and formal occupation arrangement — professional advice essential

Income Tax and Practical Considerations

Income tax on discretionary trust property: (a) Trust income tax rate: discretionary trusts pay income tax at the trust rate — 45% for non-dividend income (including rental income) above the standard rate band; the standard rate band is £1,000 (from 2024/25); income up to £1,000 is taxed at the basic rate (20%); (b) Tax pool: the 45% income tax paid by the trustees creates a 'tax pool'; when income is distributed to beneficiaries, they receive it with a tax credit for the tax pool amount — the beneficiary includes the grossed-up amount in their income and can reclaim excess tax if they are a lower-rate or non-taxpayer; this mechanism allows income to be directed to lower-rate family members over time; (c) Rental income: rental income received by the trustees is treated as the trustees' income — all allowable expenses (repairs, insurance, management fees) are deductible; mortgage interest is subject to the s.24 restriction (only 20% basic rate credit available) as in the individual landlord regime; (d) Self-assessment: the trustees must file an annual self-assessment return (SA900) reporting all trust income, gains, and any IHT events; (e) Practical structuring: discretionary trusts with rental property are expensive to administer; professional trustee fees; annual accountancy; periodic IHT valuations; legal advice on trustee decisions — these costs should be weighed against the planning benefits before the trust is established.

• Trust income tax rate: 45% on rental income above the £1,000 standard rate band — expensive for high-yielding properties
• Tax pool: mechanism that credits beneficiaries with the 45% tax paid by trustees; lower-rate beneficiaries can reclaim excess tax
• s.24 mortgage interest restriction: applies to discretionary trusts holding residential rental property — only 20% basic rate credit
• SA900 return: trustees must file an annual trust tax return; professional advice on compliance costs is essential
• Cost-benefit analysis: weigh IHT ten-year charges, CGT hold-over deferral, income tax at 45%, and administration costs against the planning objectives before settling property

Frequently asked questions