Is Equity Release Tax free?

Yes. Releasing equity in your home is tax-free.

There are two forms of equity release; lifetime mortgages and home reversion schemes. Both types are treated as a loan and a liability for tax purposes.

However, how you choose to use the money may result in you paying tax. For example, if you invested it, you may be required to pay tax on the gains.

Key takeaways

• The process of releasing equity is tax-free.
• You may face a tax liability depending on how you use the money borrowed.
• Equity release can reduce inheritance tax only if you choose to spend it.
• Be careful about re-investing the money you have borrowed as it may not always work out.

Although Equity release is tax free, you may run into some tax implications as a result of releasing equity. It's a good idea to have an understanding of these so you do not fall foul of the tax man. 

In this insight, we will clarify the tax treatment of equity release across the different tax types and explain how you could become liable.

Do you pay income Tax on Equity release?

No. Equity release is not treated as an income. With a drawdown equity release mortgage, you are able to take money from your equity release facility when you choose to, up to an agreed amount. For example, you may choose to drip-feed yourself an "income" amount each year. However, this is not treated as an income. Even though the equity is yours, from the taxman's point of view, you are actually borrowing money each time you drawdown.  

Be aware, if you were to use the equity release to generate income, then you may need to pay income tax. An example of this scenario could be if you decided to use the equity release funds to buy a pension annuity. An annuity provides you a regular income. If this income is over the income tax bracket, you will become liable for income tax. This is regardless of how you funded it in the first place.

You should carefully review your options if you are planning to borrow money to invest. It may not always go to plan.

How does Equity release impact inheritance tax?

There are three things to consider when looking into the impact equity release has on inheritance tax. That is the impact on the equity in the property, the impact on any cash left over, and the impact on any gifts.

Impact on the equity in the property

If you are over the inheritance tax brackets, the tax liability on your property will be based on the remaining equity. This is the difference between the property value and the debt amount outstanding on the equity release loan, plus the interest.

For example, if your property sells for £500,000. Your equity loan was 20% of that (£100,000), and the outstanding interest was £10,000. When the equity release loan and interest is paid back from the sale of the property, what is left will be liable for tax. In our example, that would leave a liable IHT due on £390,000.

You can pass your property to your children and receive relief. The above scenario will only apply if you leave your property to someone outside of your immediate family.

Impact on Cash remaining from Equity Release

If you have cash remaining from the release of equity, this will be included in the value of your estate. This means it will be included for inheritance tax calculations. 

If you do have cash remaining in your estate, it might be that this money can be used to clear the equity release loan outstanding after death. However, Probate will be required before that can happen though.

Impact on gifts

If you used the equity release funds to make a gift, perhaps to grandchildren. You will need to survive 7 years after the gift was made to avoid the gift being part of your inheritance tax allowance. If you die within 7 years, taper relief may apply. Taper relief means your tax rate is reduced year after year of surviving, up until after the 7th year, when 0% tax applies.

It is a good idea to plan for inheritance tax if you are expecting to be liable. There are possible strategies that can be used to reduce your liability.

Can Equity release reduce inheritance tax liability?

Yes. Equity release debt will be calculated as a liability in your estate. If you have spent the money from the equity release on anything that is not treated as an asset, you will not pay IHT on it. This would be the same logic as if you sold your house and spent all the money on holidays.

Do you pay Capital gains tax on Equity release?

No. With home reversion plans, in theory, you do sell a percentage of your home. You may think that this could create a capital gains tax liability. However, it doesn't. Equity release is treated as a loan for tax purposes. Even with a home reversion plan, there is no capital gains tax liability to pay. 

It is possible that how you use the money could result in you needing to pay Capital gains Tax. If you decide to invest the money outside of an ISA, the value could increase above the capital gains threshold. If that happens, when you sell your investment, you will be liable for capital gains tax.

When do you pay tax with Equity Release?

The tax man views equity release as a loan. There is a risk that politics and tax could change, but right now there are no tax liabilities with the process of releasing equity. The only way that a tax liability could arise would be as a result of how you have used the equity released. If you use the money in a way that could lead to a tax liability, it will not matter that the source of the money was released equity and you will still need to pay your liability. Examples of this include:

• Income tax on interest earned
• Inheritance tax on cash remaining in an estate from equity release 
• Capital gains tax on investment growth. 

Seeking Equity release advice

It's a good idea to seek advice when looking into equity release and your plans for the money. Find an adviser who is a member of the equity release council. Equity release is regulated by the FCA and the equity release council helps to maintain high and safe standards of equity release practice in the industry.

You can find equity release advisers on Sunny Avenue. Create an account to message them directly.

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