Wealth Planning
West Sussex based Accountants,
Morris Palmer, have been helping their clients to maximise
the opportunities that exist in planning their tax affairs.
In this article, Martin Carter, principal at Morris Palmer,
looks at the tax issues that surround the family home and
in particular the Gift with Reservation (GWR) rules.
The family home is often the
most valuable asset in an individual’s estate. Rising
house values in recent times has tended to focus attention
on ways of mitigating any potential tax – particularly
inheritance tax (IHT) – liabilities that may arise.
Any tax planning with the
family home is likely to be difficult for a number of reasons.
Security of tenure is often at or near the top of the list.
How many people would wish to enter into a tax planning
exercise if it threatened their right to carry on living
in the property? Add to this the ‘gift with reservation’
(GWR) rules that operate for IHT and you begin to see why
tax planning with the family home is such a minefield. Put
simply, the GWR rules render a lifetime gift of a home ineffective
for IHT if the donor continues to live there.
Getting around the GWR rules
is not easy and a variety of mechanisms have been used over
the years. One of the most popular methods currently is
the so called ‘sale and gift of debt’ scheme.
The basic elements of the
scheme are that the property is sold for full market value
to a life interest trust of which the ‘donor’
is the life tenant. He is entitled to occupy any dwelling
house owned by the trustees. The purchase price is left
outstanding as an unsecured interest-free loan repayable
at a fixed date e.g. one month after the death of the donor.
The donor then gives the debt
to another life interest trust for members of the family
(from which he is excluded from benefit). This is a potentially
exempt transfer that will not give rise to any IHT assuming
the donor survives for seven years.
From a capital gains tax perspective
the trustees have a high base cost, principal private residence
exemption is available and there will be a tax-free uplift
to market value in the first trust on the donor’s
death. Any IHT payable at that stage will be on the value
of the property less the debt, i.e. the appreciation in
value between creation of the first trust and death of the
donor. The debt would be repaid out of the proceeds of sale
of the house following the donor’s death.
There is currently some debate
about whether the scheme works. The Capital Taxes Office
of the Inland Revenue has suggested that it plans to take
a test case. Notwithstanding this the scheme is complex
and needs to be properly set up. It is certainly not something
to be undertaken by the faint hearted.
The majority view is to do
no lifetime planning with the family home. Consequently
it will form part of the estate on death and the issue then
is to ensure there is a tax efficient will. There is not
space in this article for a comprehensive review of possible
solutions but the case study below is designed to cover
a common situation and a possible solution.
Case study
Mr Smith owns a half share
in the family home worth £300,000. His wife owns the
other half and they own as tenants in common. Mr Smith has
other assets (investments and cash etc) worth £200,000.
He has never made nor does he intend to make any lifetime
gifts of capital. He has a very simple will that leaves
his entire estate to his wife on his death. He is happy
with this because he knows there will be no IHT liability
on his death due to the spouse exemption and his wife will
have full use of all of the assets until her death. However,
on her death, the IHT liability will be £100,000 higher
than it need be because the nil rate band of £250,000
was not used on Mr Smith’s death.
Mr and Mrs Smith have two
adult children so it might have been possible for Mr Smith’s
will to provide for his half share in the house to be left
to them rather than to his wife. This would effectively
use Mr Smith’s nil rate band but notwithstanding any
tax consequences there is the potential problem of the children
seeking to enforce a sale of the property due to changed
circumstances such as divorce or bankruptcy. It may be possible
once half the home has been gifted to the children for them
to settle the interest upon trust for their mother for life
then to the children for life. The point here is that the
revertor to settlor exemption provides that no further IHT
charge arises on the death of Mrs Smith. However the downside
of this approach is that it relies on the children choosing
to adopt this course of action after their father’s
death.
A further option may be for
Mr Smith to use his nil rate band by leaving the half share
in the home to a discretionary trust. The difficulty here
is that occupation of the property by Mrs Smith may mean
that the trust is treated as an interest in possession trust
rather than a discretionary trust in which case it will
still be included in her estate on death. To avoid this
problem the so-called ‘debt/charge’ mechanism
could be used instead. Mr Smith would leave all of his assets
to his wife but his will would also provide for a monetary
legacy of £250,000 to a ‘nil rate band’
discretionary trust. The monetary legacy is then satisfied
by the trustees taking a charge on Mr Smith’s share
of the house. The charge can be index linked to take account
of future increases in the nil rate band or expressed as
a proportion of the value of the house. On Mrs Smith’s
death, IHT will be payable on the whole house but the value
will be reduced by the charge.
Clearly there is no easy single
solution to effective IHT planning with the family home.
Everyone’s circumstances are different and there is
no substitute for a detailed review of each individual’s
own position. What is clear is that IHT is a potential problem
for anyone worth in excess of £250,000. Some early
planning and an effective will help enormously.
For further information, please
email us on solutions@morrispalmer.co.uk
or call us on 01403 750 444
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