"Ever since Lady Ingram first carved out a lease for life herself, and gave away the freehold of the stately home in which she resided, the great British home owning public have sought to remove the value of the family home from the charge to Inheritance Tax (IHT)". Carla Brown, Partner
Since then the tax planning industry and HM Revenue have fought a war of attrition with the former devising a succession of schemes only for them to be defeated by changes in legislation introduced by the latter.
It's probable that that there are many whose fingers are still burning from the “double trust” scheme arrangements which were popular around the turn of the century the effectiveness of which were extinguished by the introduction of the Pre-owned asset income tax charge introduced in Finance Act 2004. Having spent a considerable amount of money implementing the scheme, including a potential up front charge to Stamp Duty Land Tax (SDLT), those same individuals are now funding the cost of dismantling such arrangements.
One of the main obstacles in relation to the property is the general principle that in order for a gift to be effective for IHT purposes the person making the gift must not continue to derive any benefit from the asset given away, or pay a market rent for the continued use and enjoyment. This principle is commonly referred to as a “gift with reservation of benefit” (GROB).
Not surprisingly therefore individuals are looking for less “aggressive” ways of mitigating the potential charge to tax. Options continue to be available although the requirements of each alternative may not suit everyone. A summary of the options, in no particular order, are as follows:-
Where the main asset comprised in the estate is represented by the value of the family home the options are limited because of a lack of flexibility.
By downsizing, coupled with the release of capital, the options become more varied and include the possibility to make outright gifts of capital to intended beneficiaries which, after a period of survival of 7 years, fall out the charge to IHT on death.
In addition it creates the possibility of implementing a Discounted Gift Trust arrangement whereby a right to income is retained from the capital gifted into trust for the beneficiaries.
Property jointly occupied
There are exceptions to the GROB principle outlined above and one of those exceptions relates to a gift of an interest in a property to an individual who jointly occupies the property with the owner. In today’s society of increased divorce rates the prospect of son or daughter moving back in with mum or dad is not uncommon. Nor is it improbable that the joint occupation may come about as a result of an increased need of assistance by the parent as an alternative to residential care.
In such cases the IHT legislation provides that a gift to a donee in occupation will not be caught by the GROB provisions so long as the person making the gift does not derive a benefit as a result of the gift. An example would be where the donee assumed financial responsibility for more than their share of the cost of running and maintaining the property. As long as the person making the gift continues to bear their share of the liability, or more, there should be no problem. It is advisable for records to be maintained demonstrating that this is in fact the case.
If at any time the donee should subsequently vacate the property then the GROB provisions revive and it will then be necessary to pay a market rent in order to maintain the effectiveness of the gift.
In order to open up a wider range of options, such as outlined above in relation to downsizing but without the need to move from the property, equity may be released from the property in order to pursue an alternative strategy.
One does however need to bear in mind that, in most cases, the interest arising on the debt incurred rolls up during the life of the loan and is added to the principal debt. As a rule of thumb the compound effect is to double the debt during a 10 year period. The alternative strategy pursued with the capital released, or the benefit to the recipient if given away, needs to outperform the effect of the rooled up interest, taking account also of the potential saving of IHT.
Payment of rent
As outlined above, it is possible to perfect the gift for IHT purposes by paying a market rent for the continued use of the proportion of the property given away.
In my experience there is always a psychological barrier to be crossed when considering this option. Most people spend part of their life pursuing the dream of owning their own home, unencumbered, and therefore the prospect of paying a market rent to occupy something they already own is difficult to accept. In a sense I share that scepticism but only in instances where it involves the payment of rent to a third party landlord. The reality of such arrangements though is that the rent will be paid to the intended beneficiaries who are now the owners, either wholly or in part, of the property.
If mum, or dad, enjoy a healthy level of income in retirement, this can be used to support the rental payments. In all probability that surplus income, if not used for rent, would either be spent in support of the family in any event or would accumulate as surplus capital thereby increasing the potential IHT liability. It is important to be open minded.
Giving away the roof over your head and control of it is never a decision to be taken lightly. Certainly in such cases the “tax tail should never wag the dog”. The right to remain in your own home, whatever change in circumstances may occur for your beneficiaries must take priority over the desire to save tax for their benefit.
The risk that a beneficiary may become bankrupt or be involved in an acrimonious, and expensive, divorce cannot be discounted.
The purpose of this article is to outline what possibilities exist for IHT mitigation in relation to the family home and do not endorse one particular route or product. Each case must be considered based on the particular facts.