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Business Tax  •  IHT  •  Personal tax  •  Probate and Inheritance Tax  •  Tax Planning  •  Taxation

An Englishman’s home is his castle – and biggest tax liability

By RJP LLP on 29 September, 2011

If you live in the South East of England, your home is quite likely to be your biggest single asset, especially considering how much house prices have risen in the last decade (in spite of the recent dip). For most taxpayers, this is an asset you’ve paid for slowly, with hard-earned cash, probably after working for many years. You’ve paid plenty of tax already on the money you’ve invested and you want to be able to keep your home indefinitely, passing it on to your family for the future. That’s not an unreasonable expectation.

However, if the value of your family home is more than £650,000 for a couple or £325,000 for an individual, based on current figures it will be liable to inheritance tax (IHT). IHT is avoidable if you make lifetime gifts from which you derive no future benefit, but it is of course difficult to do this where your home is concerned.

This article aims to help taxpayers 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. Before going into the tax details however, it’s important to stress the importance of having a valid will in place; this is a starting point in effective IHT planning and one which is often delayed or avoided. Without a will you have no ability to control who is to inherit your assets and no ability therefore to undertake inheritance tax planning. In addition, the administration of your estate will be unnecessarily complex.

Common obstacles to IHT planning for the family home

Things would be so much easier if you could just put your home in your children’s names and carry on living there. Sadly this is not possible and HMRC have a series of criteria which much be met for any IHT planning strategy to be valid. Therefore before you give away any asset, you must be aware of the following:

  1. If you make a gift of any asset, in order for that gift to be effective for IHT purposes you must make the gift absolutely and must not continue to benefit from the asset in any way;
  2. If you make a gift of an asset but retain any right to enjoyment from it, not only will the gift not be effective for IHT purposes, but it may give rise to an income tax liability based on the benefit of that enjoyment;
  3. If you make a gift of an asset you should always consider whether capital gains tax (CGT) applies – where a gift is made to a ‘connected party’ for example a relative, HMRC can substitute the market value of the asset for the consideration actually received, and as a result a CGT liability may arise;
  4. If you give away everything, or nearly everything you own thereby leaving no provision for future care costs, you may be denied access to local authority care facilities. This is known as ‘deliberate deprivation’;
  5. If you give away assets in order to ‘protect’ them in your old age, this will not be effective as far as care costs are concerned if you make the gift at a time when you anticipate you may need care.

So, whatever IHT saving strategies you put into place need to take into account these aspects to ensure any tax planning you do is not invalidated, and does not give rise to unforeseen liabilities.

There are two types of tax planning to consider in relation to the family home:

1. Lifetime planning
You are able to make any level of gifts during your lifetime and provided you survive for 7 years following the gift it will fall outside your estate entirely. A tapering relief also applies from 3 years following the gift. Are you able to make a lifetime gift of the family home?

a) If you do this you lose the right to live there, and for the gift to be valid for IHT purposes you will need to pay a normal market rent to the new owners. Of course if you can afford to do this, then the payment of rent is in itself a good IHT planning strategy since the amounts paid will fall outside your estate immediately and will not be subject to the 7-year rule outlined above. But in most cases you won’t know how long you will be paying rent for and whether you can afford it for the rest of your life. If you give away your home to your children for tax reasons and then rent it from them, you will need to be sure you have sufficient finances to sustain this commitment and maintain your normal standard of living.

b) You can give a share in your home to an adult child lives with you and who shares the running costs, and this can be effective for IHT purposes.  This does however need to be a permanent arrangement and you will need to provide firm evidence to HMRC to prove that the other person with a share in the house is also responsible for their share of maintenance costs. If this is not the case or if indeed the other person moves out at a later date, the value of the house will be added to your estate once again.

c) You can of course sell your home and downsize. Many people consider this and may go on to purchase a new property below the IHT threshold. If you have the means, you may wish to gift some of the remaining cash outright to your beneficiaries in order to take advantage of the 7-year rule. This also 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 assets within the family. Trusts are complex and must be set up by an expert after taking advice to weigh up the pros and cons. There will also be ongoing running costs associated with this approach. Find out more about the pros and cons of trusts in our earlier article.

d) If the above alternatives are not for you but you would still like to reduce the IHT payable on your family home, there are additional tax planning opportunities available connected with the creation of debt against the property, and additional advice can be sought.

e) And if all else fails, at the very least you should 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 in a hurry. If you do this, you should ensure the capital from the policy is payable directly to your beneficiaries and that it does not revert to your estate, thereby increasing the IHT liability.

2. First death planning
For many couples IHT will not be payable on the first death, since property will be left to the surviving spouse or civil partner and will be covered by the spouse exemption. This does not however provide certainty to either party that the surviving spouse will deal with the property as they would wish. Therefore many will want to make separate provision, but will also wish to ensure the surviving spouse can continue to live in the property for as long as they want to do so.

Property is often owned jointly, so that it automatically reverts to the surviving spouse, however if the ownership is changed from joint to ‘tenants in common’ an individual share in property can be left to a third party. Once the property ownership has been altered if necessary, it is then possible to consider a number of planning options. The most common route is for a will provision to be made which states that a half share in the property is to be left on trust to children on the first death, with the surviving spouse being entitled to live in the property for the remainder of their life, or to use the capital from the property to acquire a different property. On the second death, the first half share in the property reverts entirely to the children; this enables the first deceased partner to retain control over the ultimate ownership of their share of the property.

In this article we are only able to provide a summary of the issues arising; IHT is complex and planning for it often highlights many practical and emotional considerations. Decisions relating to your assets should never be made lightly as once you have given property away, this cannot be reversed. Whatever you decide to do, and if you decide to do nothing, at the very least make a will and remember that you should never make decisions purely on the basis of tax savings; it has to be right for you as an individual.

RJP are holding a series of special IHT surgeries to help clients navigate the different options to consider. Each surgery costs £300 instead of the usual price of £1500 and will include an analysis of what the most tax efficient strategies might be with recommendations on how to implement the advice.

To find out more, email Lesley Stalker at las@rjp.co.uk.

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