THE introduction this month of the land & buildings transaction tax has helped fuel an upsurge of activity in the Scottish prime residential market. Competitive bidding at closing dates has been particularly prevalent for good-sized city family homes, in many cases helping sale prices to exceed home report values. Rising markets and sustained demand mean the family home continues to occupy a sizeable portion of family wealth. If downsizing is undesirable, this can create potential inheritance tax (IHT) headaches.
In many situations, the family home is the asset of last resort, often left by will between spouses or civil partners, attracting full IHT relief on first death. Two nil rate bands (totalling £650,000) may be available to apply against the survivor’s estate, before tax bites at 40 per cent on any excess value. Beneficiaries inheriting the family home in this way have the option to settle IHT by annual instalments over ten years, although the Revenue sets the rate for servicing this debt, currently 3 per cent.
We know the Conservative Party’s aspiration to raise the nil rate band to £1 million actually only targets main residences, favouring this class of asset over others. The policy outlines a proposed new allowance of £175,000 per person, transferable among spouses and civil partners, which would enable parents to pass this asset down to children free of tax up to £1m. In the absence of this mechanism from last month’s Budget, and where family objectives are aligned, there are opportunities to manage this problem area.
Making a gift of the family home to children, while continuing to live there, can be effective, but only if a market rent is always paid by parents for their occupation. This prevents a reservation of benefit arising, which would make the gift ineffective for IHT. The gift would be treated as IHT-exempt only once the donors have survived seven years. One drawback is that the treatment of rent as taxable income in the recipients’ hands is not an efficient transfer of family funds. The key risk following any transfer of ownership of property is the exposure to the personal and financial circumstances of the recipient family members. If anything serious were to go wrong in life, marriage or finance, the parents could be unseated from their tenancy.
With the age of first-time buyers continuing to rise, house-sharing options are often explored among families. Transferring part of the ownership in the family home to a child is viable where there are genuine mutual family interests and the property is, or can be made, suitable for shared living. This can achieve the twin objectives of acceptable tax planning within the law, and succession planning to pass the family home down to the next generation. An undivided share in property can be transferred by gift or sale, and capital gains tax will be relieved where the disposal is of the principal private residence.
By giving away a share, parents retain security of occupation through their ownership and rent is often not required.
Co-occupation of the home is required and everyone involved should meet the cost of their shared use of domestic expenses, to prevent a reservation of benefit by the donor parents. Subject to this, the value of a gifted share of the family home can be IHT free after seven years.
If affordable in terms of price and transaction tax, another option is to sell part of the family home to a child and share the home together. If borrowing is needed, beware lending criteria as banks will likely require all owners to be bound by mortgage terms, which carry legal and practical issues.
Anti-tax avoidance rules govern this area closely and while a sale of the whole family home (followed by co-occupation) is permitted, a part sale can trigger a charge to pre-owned assets tax.
The option of combining gift with sale by transferring the property or a part of it among the family, at a discounted price, is also viable and requires careful consideration given the potential hurdles.
Helping family members onto the housing ladder and sensible succession planning should be the key drivers here, but the potential inheritance tax saving is attractive.
It is important to weigh up the legal, tax and practical implications of your particular circumstances as part of the early planning phase, to ensure compliance with the rules, and to have a written agreement to protect the best interests of all your family, and your home.
• Chris Sheldon is a partner at Turcan Connell www.turcanconnell.com