Homeowners whose property is their main asset
For a vast majority of people the family home is the most valuable asset in their estate and given that property values have risen significantly over the past few years, more and more people are likely to be subject to inheritance tax (IHT) due to the value of their property. Tax planning opportunities involving the family home are limited but there are still opportunities for utilising the family home in IHT planning. This briefing note aims to help homeowners understand the difficulties surrounding IHT and the family home and looks at what steps you might be able to take when planning to reduce your liability. It is, however, important also to consider other taxes which may be applicable in such planning and in particular Capital Gains Tax and Income Tax. In this note we only look at the IHT issues.
The starting point in effective IHT planning is to ensure that you have a valid Will in place. However, it is often the step that tends to be delayed or avoided. Making a Will is key in ensuring that your estate is shared out exactly how you want when you die. If you do not leave a Will, you have no ability to control who is to inherit your assets, and your estate will be shared out among your next of kin according to a strict order of priority called the ‘rules of intestacy’. This means that people you want to benefit from your estate may not get anything.
CO-OWNERSHIP OF PROPERTY
There are two ways of holding property jointly – as joint tenants or as tenants in common.
As joint tenants you own the whole of the property together and you are each deemed to have an equal share. On first death, the deceased’s interest passes automatically to the survivor and cannot be left under the deceased’s Will. For spouses and civil partners, the transfer will be exempt from IHT.
As tenants in common you each hold a distinct share of the property, which can be unequal, for example, to reflect each of your contribution to the purchase price. Each share is a separate item of property and can be disposed of during your lifetime or under the terms of your Will. For this reason, a tenancy in common can sometimes be considered as the most suitable way for co-owners to hold property from an IHT planning perspective.
For IHT purposes, giving your property away while you are alive is treated as making a gift. There are two points about gifts to be aware of when passing on property: 1. You can make an outright gift of your property to someone and it will be exempt from IHT if you live seven years after making the gift. This is known as a Potentially Exempt Transfer; and 2. If you give your property away with conditions attached to it, or if you continue to benefit from the home yourself, this is known as a ‘gift with reservation of benefit’ and the gift will not be exempt from IHT even if you live for seven years after. There may also be Income Tax and Capital Gains Tax implications.
IHT PLANNING – THE OPTIONS
Homeowners should think very carefully before compromising their security and tenure and that IHT planners should only enter into arrangements which involve the main residence as a last resort. Notwithstanding this warning, some options are as follows:
GIFTING YOUR PROPERTY AND PAYING MARKET RENT
If you give your property away and then later decide to live at the property you will need to pay an open market rent to prevent the gift failing for IHT purposes. If you give away your property to your children, for example, for IHT planning purposes you will need to be sure that you have sufficient finances to sustain the payment of rent and maintain your normal standard of living.
GIFTING YOUR SHARE OF THE PROPERTY AND SHARING RESIDENCE WITH CO-OWNERS
Another option is to give a share in the property to someone else (for example an adult child) and who shares the running costs of the home. This does however, need to be a permanent arrangement and you will need to provide evidence to HMRC to prove that the other person with a share in the property is also responsible for their share of the maintenance costs. If this is not the case or if, for example, the other person moves out at a later date, the value of the property will be added to your estate once again.
DOWNSIZING AND RELEASING CAPITAL
Many people choose to sell the family home and downsize to a property below the IHT threshold in their latter years. If you have the means, you may wish to gift some of the remaining cash from the sale of the family home to your children in order to take advantage of the 7 year rule, as described above. This offers the potential to create a trust with the remaining capital, in order for example, to provide for grandchildren according to their differing needs over the years and to retain the assets within the family.
Remortgaging your property by equity release could be another way to reduce the IHT payable. However, this has the very significant draw-back in that the borrowing will normally incur high interest charges.
A further option is to consider taking out life insurance to cover the IHT liability (or part of it) arising on the second death. This will ensure your beneficiaries have cash available to meet the liability and are not forced to sell assets, such as the family home. If you do this, you should ensure that the capital from the policy is payable directly to your beneficiaries and that it does not revert to your estate, as this would have the effect of increasing the IHT liability.
It is possible to create IHT savings in respect of the family home by using one of the options discussed above, but, as we have seen, these are rather limited. It is also important to ensure that with any IHT planning it does not invalidate or give rise to unforeseen liabilities. For example, local authority support for residential and nursing home care fees may be compromised where an individual has gifted away their family home under the “deliberate deprivation” rules. A good starting point is to have a well drafted Will and to then consider what options, if any, suit your personal needs.