Nowadays most of us have the majority of our estate tied up in our family home, but how do we make the most of our inheritance tax planning opportunities?
Below are some of the straight forward ideas and some of the damn right silly ideas, so please see the appropriate professional advice before putting any of them into action.
It is often the case that someone wishing to mitigate IHT has little or no scope in doing so via lifetime transfers of income-producing assets, or indeed via any other assets except the family home.
Gifts with reservation of benefit are ineffective, and there is the pre-owned assets (POAT) income tax charge to consider. There are also the associated operations rules to look at as defined in Section 268 IHTA1984. These include “any two operations of which one is effected with reference to the other, or with a view to enabling the other to be effected or facilitating its being effected, and any further operation having a like relation to any of those two, and so on”. They are then treated as a single transfer of value, made at the time of the last of them.
Finally, there is the attack on life interest trusts and A&M trusts. Many methods of mitigating IHT on the family home involve the former, usually for protection purposes rather than as a fundamental part of the tax effectiveness of the scheme. The attack is unlikely to cause any major problems to those schemes where the value is within the nil-rate band, but in other cases it may be necessary to pass the capital absolutely.
Despite these problems to overcome, there are still a few schemes which can create IHT savings by using the family home. This of course is quite apart from the effectiveness of the parents gifting the home to their children and paying market rent for the continued occupation. Although this would seemingly not be a feasible solution, as the parents pay the rent out of after-tax income and the children pay income tax thereon, it does provide the means to get further funds out of the parents’ estates. However, the children lose the CGT private residence exemption whilst their parents are occupying.
The effectiveness of each scheme depends on the personal circumstances, requirements and beliefs of all parties involved. That in itself can create difficulties.
Ownership of property
Action as a result of the new rule allowing the surviving spouse to use the nil-rate band not utilised on the first death includes:
♦ IHT exposure reduced generally but mitigation still needs to be considered where joint estates exceed 2 x the nil-rate band.
♦ Ensure that the family home is jointly owned as joint tenants rather than as tenants in common.
The latter has been a popular way to ensure that the nil-rate band of the first spouse to die is utilised (depending on property value) as he passed his share to, say, his children. However, it was always questionable from a practical viewpoint as it relied on the children allowing the surviving parent to continue to occupy. The parent cannot be evicted, but there will be clear financial problems if the children become bankrupt, or they put in a tenant, or they force a sale. This is quite apart from the emotional upset caused to the parent who is likely to be elderly, and the CGT exposure on the children if the property was sold. Fortunately, such action is no longer needed and the surviving spouse can safely be left to own the property outright on her husband’s death.
Donor/donee joint occupation
The parents make unconditional gifts of undivided shares in the house to their children and the parents and children occupy as their family home. Each owner bears his or her share of the running costs.
The parents’ occupation or enjoyment of part of the house that they have given away is in return for similar enjoyment of the children of the other part of the property. The donors’ occupation is then for full consideration as it is on the basis of being tenants in common. There is no reservation of benefit, with Section 102B(4) FA1986 applying. There is also exemption from the POAT charge. If the children move out, the value of their share is included in the parents’ estate again.
This type of arrangement will usually not be realistic, but there are some circumstances where it can have practical application:
♦ A holiday home where each member of the family occupies on a commensurate basis and the donee(s) do not pay more than their share of the outgoings.
♦ A widow owns her home. Her daughter becomes divorced and moves in with her mother who gifts a 50% share to her as tenants-in-common.
Splitting the property
If the family home has scope for conversion into flats; or creation of separate living space in the loft; or creation of a separate dwelling in the gardens, this can give rise to IHT savings as the new space (or indeed the old) could be the subject of a lifetime gift with no reservation of benefit issues.
Moving to smaller property
This simple solution may well be attractive, with the capital released then being gifted. The parents may prefer to move to a smaller property in retirement.
Cash gift now; house back later
This type of arrangement is fraught with practical difficulties but might be regarded as acceptable by a client who is desperate to reduce IHT.
Father could, say, make a cash gift of the nil-rate band to his son even though he has no desire to benefit him until death. He could borrow the funds on the security of his own house if necessary and that would mean a further reduction in his estate. After 7 years the son buys a property for his father to live in (or buys a % of it if the purchase price exceeds the cash gift made to him 7 years’ earlier). Father sells his house at the same time, and repays any loan secured on it. The 7 year wait ensures avoidance of a POAT charge.
Problem areas include:
1. Associated operations rules.
2. Son may decide to keep the money.
3. Son may suffer marriage problems, and his wife could seek some of the cash gifted to him.
Some of the possible problems could arguably be alleviated if the son purchased the property straight away from the cash gift, and then lets it to a third party for 7 years.
Donees use own resources
If parents want to gift the family home to their children and still occupy it, clearly this is a GWRB.
If instead they gift cash to the children to enable them to purchase the home at market value, this creates a POAT charge rather then a GWRB.
A possible solution is for the children to purchase the home from their own resources (not via a previous gift from the parents) with a mortgage if necessary. Subsequently the parents gift cash to the children. This does not result in the contribution test being met under Para 3(3) Sch 15 FA2004, so no POAT charge arises. The IHT associated operations rules do not apply to POAT.
There is no GWRB charge if market value is paid by the donors who continue to have full possession of the items such as jewellery, works of art and other valuable personal possessions. As market rent is likely to be in the region of only 0.75% of the market value of the items, where the donor continues to pay the insurance, this gives plenty of scope for some useful IHT mitigation.
However, despite market value being paid, this supposedly does not stop a POAT charge arising, on the dubious grounds that there is no real recognised market in leasing personal possessions, and a return on capital of 4% has to be taken. This applies to chattels from 6 April 2010 and is fixed at the same rate as the official rate of interest on beneficial loans.
It has been reported that HMRC now reluctantly accepts that what is market rent to avoid a GWRB charge also applies to avoid a POAT, in which case there is clearly plenty of potential here. If the family home is also to be gifted, with avoidance of a GWRB or POAT by paying market rent, arranging for the property to be let furnished can result in the chattels automatically being included with no additional rent likely to apply.
The 1999 anti-avoidance legislation to stop the Ingram scheme should not apply where the parent has owned the interest in the property for at least seven years, and accordingly continues to occupy the property as a result of that pre-existing right. The interest owned is of course the lease granted, say, to himself and his spouse for a specified number of years which will exceed the survivor’s expectancy of life. After seven years the freehold reversion can be gifted as a PET under existing legislation, but this time-frame will not be regarded as acceptable by some clients.
A successful pre- 9 March 1999 Ingram scheme is caught by the POAT charge. The options to mitigate the tax position are as under:
♦ pay the POAT tax charge on the full rent for the property, discounted to reflect the value of the retained lease (this should not create a substantial tax charge where at least 7 years have passed and the PET of the freehold has resulted in no IHT)
♦ pay the POAT charge if the taxpayer is in poor health and (say) has a life expectancy of no more than 5 years
♦ cease to occupy the property if that is possible, thereby retaining the IHT advantage but with no POAT charge
♦ go for the transitional relief and elect for the property to form part of the estate; however, this will create a ridiculous problem if the donor subsequently ceases to occupy the property as he will then have made a PET with the 7 year period restarting
Equity release schemes
There are several types of scheme. Some involve selling a % of the property with the right to continue to reside until death or until moving to a nursing home. Borrowing cash from, say, a son and charging the property as security presents no problem but if the son purchased an interest in the property there is a POAT issue.
A simple form of equity release, known as a cash release scheme, involves the owner taking out a fixed-rate mortgage on an interest-only basis. The interest is accumulated over the life of the mortgage, and the mortgage is repaid on the death of the borrower or moving into long-term care. The capital raised could, if appropriate, be gifted to a beneficiary as a PET where the desire (and/or need) is to benefit him now but there is little or no free capital available (or any other capital must be retained to provide income). The mortgage reduces the property value for IHT purposes and effectively serves to fully reduce the estate by that amount after 7 years when of course the PET has become an exempt gift.
Typical levels of release are as follows:
age- % of value
This is simple IHT planning but care is needed and in particular by taking a fixed-rate mortgage it should be possible to obtain a guarantee that the amount owed will not exceed the value of the house, thereby ensuring no risk of negative equity.
This is effectively a form of equity release. The stages are:
♦ owners sell the property to the fund for full market value, with the fund paying SDLT
♦ owners do not receive the cash – instead they receive two assets
♦ first is a lease to allow them to live rent-free in the property for the rest of their lives
♦ second is the balance of consideration (after careful valuing of the lease above) in the form of units in the fund which will own several properties
♦ if appropriate, the unit holders could then gift some or all of them as a PET, but the units should be more valuable when the fund sells a property with vacant possession after the lease has ended
Funding care home fees via the family home
A Care Fees Payment Care Plan involves the payment of a lump-sum premium to the provider, who then guarantees to pay the shortfall in care fees for as long as necessary. The plan is limited to the elderly who have assets in excess of the means-tested threshold for Social Services financial assistance, and are about to receive care. The minimum age is 50 but the individual has to fail at least one ADL (activity of daily living).
Instead of selling the family home to pay the premium, it could be let and a secured loan taken out. The interest is tax deductible against the rent from the date the property was first made available for letting, as at that time a notional lettings business commenced and the property was transferred to that business. The loan reduces the value of the property for IHT purposes as it is secured on the property.
Borrowing on the property
As stated above, secured borrowings reduce the value of the property for IHT purposes, irrespective of the use made of the funds borrowed. They could be invested in, for example, shares in an AIM quoted trading company with the result that 100% BPR is available after two years.
The investment risk must be the deciding factor, and in practice this strategy is only feasible where the home owner has some link, commitment or firm desire to invest in the company.