How does inheritance tax affect HMO properties?

Inheritance Tax (IHT) planning is a complex but crucial component of wealth management in the UK, particularly for individuals holding significant property portfolios. Houses in Multiple Occupation (HMOs) present a unique challenge in this area because their tax status for IHT purposes hinges heavily on how actively they are managed and the type of services provided to tenants. The difference between classifying an HMO as a passive investment versus an active trading business can mean the difference between a 40% tax charge and full relief.

How Does Inheritance Tax Affect HMO Properties in the UK?

Inheritance Tax is levied on the value of a person’s estate when they die, above the available threshold (known as the Nil-Rate Band, currently £325,000 for the 2024/25 tax year). The standard IHT rate is 40%. For property owners, understanding the tax treatment of their assets, especially complex assets like HMOs, is vital for effective estate planning.

For IHT purposes, all assets are valued at their market price at the date of death. HMOs, which are often valued higher than standard single-let properties due to their higher yield potential, contribute significantly to the overall estate value.

The core issue affecting HMOs under IHT legislation is whether the property business qualifies for Business Property Relief (BPR). If BPR applies, the taxable value of the asset can be reduced by 50% or even 100%, significantly mitigating the IHT liability.

The Crucial Test: HMOs and Business Property Relief (BPR)

Business Property Relief is a valuable tax relief designed to protect family businesses and genuinely trading entities from being broken up to pay IHT. The relief is typically available at:

• 100% relief: For a business, or interest in a business, or unlisted shares.
• 50% relief: For land or buildings owned by the deceased and used wholly or mainly for a business carried on by a company they controlled or a partnership they were a member of.

However, BPR legislation specifically excludes businesses that consist “wholly or mainly” of dealing in securities, stocks or shares, land or buildings, or making or holding investments. This exclusion directly challenges standard rental property businesses, including most typical buy-to-let HMOs, which HMRC generally views as passive investments.

Investment Activity Versus Trading Activity

The distinction between an investment and a trading business is subjective and often determined through case law. Simply collecting rent, arranging minor repairs, managing licenses, and finding new tenants—which constitutes the primary activity of many HMO landlords—is generally deemed an investment activity.

To successfully claim BPR on an HMO portfolio, the estate must demonstrate that the operation involves substantial, non-investment activities that go beyond the basic duties of a landlord. The key test is whether the business activity is “wholly or mainly” (meaning more than 50%) non-investment based.

When Can an HMO Qualify for BPR?

While standard property letting typically fails the BPR test, there are situations where an HMO operation may qualify. This usually requires the provision of services akin to a guesthouse, hotel, or care home, shifting the balance from passive property ownership to active service provision.

Services that HMRC and UK courts have historically considered relevant for BPR qualification include:

• Extensive Maintenance and Cleaning: Daily or weekly cleaning of communal areas, bedrooms, or even providing housekeeping services.
• Catering or Meals: Providing food or meal preparation services.
• Specialised Management: Offering services that are clearly separable from simple property management, such as care or support for vulnerable tenants, or concierge services.
• High Tenant Turnover: Properties operating more like serviced accommodation or short-term lets, where management input is necessarily high, may stand a better chance, although short-term holiday lets (Furnished Holiday Lettings) have their own specific criteria.

If the level of activity is sufficient, the HMO business could be classified as an active trading business, potentially making the assets eligible for 100% BPR. Legal precedent has shown that the sheer scale of the operation or the complexity of management is usually insufficient unless accompanied by substantial non-landlord services.

It is crucial that the deceased owned the business assets for at least two years immediately prior to their death for BPR to be claimed.

Valuation of HMOs for Inheritance Tax Purposes

When assessing IHT liability, the valuation of the HMO property is critical. Unlike a standard dwelling, an HMO is valued based on its income-generating potential, and the valuation must account for complexities such as licensing status and the tenancy agreements in place.

If the HMO is being run as a legitimate business that qualifies for BPR, the valuation process may focus on the business entity itself (its goodwill and net assets) rather than just the physical bricks and mortar. However, if BPR fails, the property will be valued as a rental asset, often requiring a specialist surveyor with expertise in multi-let properties.

If the deceased person’s estate includes their main residence, the Residence Nil-Rate Band (RNRB) may also be available, currently up to £175,000 (2024/25), provided the home is passed directly to children, grandchildren, or other direct descendants. This relief is separate from any BPR considerations.

For precise information on current IHT rates and reliefs, it is advisable to consult official sources such as HMRC’s guidance on Inheritance Tax.

Strategies for Managing IHT Liability on HMOs

Given the uncertainty surrounding BPR qualification for standard HMOs, proactive estate planning is essential to mitigate potential 40% tax charges:

1. Structuring the Business for BPR

If the goal is to secure BPR, the property owner must intentionally increase the level of non-investment services. This usually means formalising the service provision, maintaining detailed records of management hours, staff employed, and costs incurred for services beyond basic landlord duties. An HMO owner must be able to prove that their primary activity is providing services, not merely collecting rent.

2. Gifting the Property

Gifting the property during the owner’s lifetime can reduce the taxable estate. If the donor survives for seven years after making the gift, it becomes a Potentially Exempt Transfer (PET) and falls completely outside the IHT calculation. If they die within seven years, it becomes a chargeable transfer, though the tax liability may be tapered.

Warning: If the donor continues to benefit from the property (e.g., lives there or continues to receive income), the gift may be treated as a Gift With Reservation of Benefit (GWROB) and remain within the estate for IHT purposes.

3. Using Trusts

Placing properties into appropriate trusts can be an effective way to manage IHT liability, though complex rules apply depending on the type of trust used (e.g., discretionary trusts vs. bare trusts). Transferring assets into trust may incur an immediate tax charge (a lifetime charge) if the value exceeds the Nil-Rate Band.

4. Life Insurance

A simple, non-tax strategy is to take out a whole-of-life insurance policy written under trust. The payout can be structured to cover the expected IHT liability, ensuring beneficiaries have the funds available to pay the tax without needing to sell the HMO property quickly or under duress.

People also asked

Can a buy-to-let property ever qualify for Business Property Relief?

Generally, no. HMRC views standard buy-to-let properties as passive investments that consist “wholly or mainly” of holding investments, meaning they are excluded from BPR. Only when the landlord provides exceptional and extensive services, transforming the holding into an active trading business, might BPR be considered.

How long must I own the HMO for BPR to potentially apply?

The deceased must have owned the relevant business property or shares for at least two years immediately before their death. This two-year minimum holding period must be met even if the property qualifies as a trading business for BPR purposes.

If I run my HMOs through a Limited Company, does that change the IHT treatment?

Running the business through a Limited Company can facilitate BPR if the company itself qualifies as a trading entity (i.e., less than 50% of its activities are deemed investment activities). If the company owns shares in other trading companies, 100% relief may be available on the shares. However, if the company’s main activity remains passive property rental, the shares may still fail the BPR test.

What happens if I inherit an HMO with an outstanding mortgage?

The outstanding mortgage liability is generally deductible from the value of the property when calculating the estate’s net value for IHT purposes. The executors are responsible for settling the IHT bill based on the net value of the estate before transferring ownership to the beneficiaries.

The classification of an HMO for Inheritance Tax purposes is highly fact-specific and requires careful analysis of the business operation. Property owners with significant HMO portfolios should seek professional advice from a solicitor or tax advisor specialising in estate planning and BPR to accurately assess their potential liability and structure their affairs efficiently.