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29 November 2000
Death and the Home
Tax efficient will planning in relation to the family home is examined by Ralph P Ray FTII, BSc(Econ), TEP, solicitor.
The matrimonial home is one of the assets that can be used to ensure that each spouse has assets of the value of the nil rate band. This can be achieved by placing the asset either into the sole name of one spouse or into joint names as tenants in common depending upon circumstances. As regards the holding of land and building in joint names, there are two alternatives:
joint tenants; or
tenants in common.
Tax efficient will planning in relation to the family home is examined by Ralph P Ray FTII, BSc(Econ), TEP, solicitor.
The matrimonial home is one of the assets that can be used to ensure that each spouse has assets of the value of the nil rate band. This can be achieved by placing the asset either into the sole name of one spouse or into joint names as tenants in common depending upon circumstances. As regards the holding of land and building in joint names, there are two alternatives:
joint tenants; or
tenants in common.
Death and the Home
Tax efficient will planning in relation to the family home is examined by Ralph P Ray FTII, BSc(Econ), TEP, solicitor.
The matrimonial home is one of the assets that can be used to ensure that each spouse has assets of the value of the nil rate band. This can be achieved by placing the asset either into the sole name of one spouse or into joint names as tenants in common depending upon circumstances. As regards the holding of land and building in joint names, there are two alternatives:
joint tenants; or
tenants in common.
Where property is held as joint tenants, the survivor takes absolutely and by operation of law. Hence it is impossible to make testamentary or lifetime dispositions to third parties (in the absence of a deed of variation). By contrast in the case of a tenancy in common, disposals of one spouse's or co-owner's shares during lifetime or by will are possible, e.g. to children, and hence this method of holding is generally to be recommended as affording greater flexibility. In particular as a tenant in common of part, a co-owner, e.g. a widow, would be entitled to occupy the whole (but see reference to Lloyds Private Banking Ltd below). On her death, moreover, her share would be eligible for a discount of between ten per cent to 15 per cent (see Dymond Capital Taxes page 23.520).
There are, however, two possible danger areas:
the loss on the creation of such an interest would be greater and taxed at that time. For example, father A transfers his house into joint names of himself and his son. Before the transfer, the house was worth, say, £200,000; afterwards A's half share is worth, say, £90,000. On the consequential loss formula A's transfer of value is £110,000;
the other co-owner(s) may be able to force a sale as the house would be held on trust for sale, sections 34 and 35, Law of Property Act 1925. This danger has diminished since 1 January 1997 because under section 5 of and Schedule 2 to the Trusts of Land and Appointment of Trustees Act 1996, there is no longer a duty to sell, and the trustees have a statutory power to postpone sale.
In cases where the property is held as joint tenants, but it would be preferable for it to be held as tenants in common, it is a relatively simple matter to sever the joint tenancy to make it into a tenancy in common.
If an individual, for instance, a widow, is given any right to occupy the matrimonial home, this will normally constitute an interest in possession, so that the same inheritance tax will be payable as if the house had been given outright. If the interest terminates more than seven years before the individual's death, a potentially exempt transfer will arise at that time and the seven-year period will have been satisfied. In order to avoid this, any such occupation must be informal, for instance, by way of a non-enforceable licence or permission (there should be no gift with reservation problem, because the donor is the deceased who cannot by definition have reserved a benefit, and because inter-spouse gifts are outside the gift with reservation provisions). See Sansom v Peay [1976] 3 All ER 375 and Inland Revenue press release dated 15 August 1979 referring to Statement of Practice 10/1979.
Sufficient security of tenure is likely to exist in practice if the surviving spouse is an executor or executrix of the will.
If the testator owns the entire home and wishes to leave most of the value in it to a chargeable party, e.g. his son, yet enable his widow to occupy the house without retaining a life interest in the whole chargeable on her death, he could consider giving the widow, say, a 25 per cent tenant in common share, with 75 per cent to the son. The widow would then be able to occupy the whole property by virtue of her 25 per cent tenancy in common. There must not be a bar against the son occupying as co-owner, as such a bar would give the widow an interest in possession in the whole; and see the Lloyds Private Banking Ltd case below. This can be adapted further as follows.
Recommended routes
Proposal 1
(See also 'The Principal Private Residence Part I' by James Kessler in Taxation Practitioner dated November 1990.)
The following situation can satisfactorily be achieved by the use of a flexible life interest in favour of the surviving spouse (assuming that the husband/testator owns the home – or a share in it – and leaves a widow). The relevant steps would include the following:
the will establishes a flexible life interest of the whole home (or share) in favour of the widow in the testator's will;
after the testator's death, the trustees (of whom the widow could possibly be one – but see below) appoint, say, 75 per cent of the life interest (i.e. income/occupation entitlement) in favour of the children, the trust remaining subject to the wide overriding powers of appointment;
the widow remains in occupation, although not exclusively, i.e. the children must not be barred from occupying the home as well if they wish, (a professional trustee may wish to be armed with an indemnity from the children);
the widow and other co-owners could be given an option to acquire the other's interest at market value by way of first refusal. This will help if a co-owner wishes to force a sale – a danger reduced by section 5 of, and Schedule 2 to, the Trusts of Land and Appointment of Trustees Act 1996 – see above;
requiring the widow (or other co-owner's) consent to a sale is not recommended as it may constitute an interest in possession;
the trustees should consider receiving an indemnity from the children that the widow need pay no rent.
The advantages of this approach include:
the inter spouse exemption on the husband's death on the whole property (section 18, Inheritance Tax Act 1984);
the termination of the widow's full life interest in whole or part, e.g. 75 per cent, is a potentially exempt transfer;
the gift with reservation rules should not apply because as a co-owner the widow is by law entitled to occupy the whole, and also because the termination is not 'a disposal by way of gift' under section 102, Finance Act 1986 by the widow – but an act of the trustees – a deemed transfer of value – (for this reason it is somewhat safer if the widow is not a trustee);
with regard to capital gains tax, if the property is sold at any time during the widow's lifetime (or three years thereafter), capital gains tax private residence exemption should be available by virtue of section 225, Taxation of Chargeable Gains Act 1992 – as the widow is 'entitled to occupy it under the terms of the settlement'; and as a co-owner (whether as joint tenant or the recommended tenancy in common) the widow is entitled to occupy the whole of the home, even though she is not solely entitled to occupy. By virtue of section 94(2), Finance Act 1991, the widow would not necessarily have had to so occupy the home during the 36 months prior to the sale.
Proposal 2
The testator leaves the home (or his share of it) and possibly other assets, for instance, shares of residue, to son X.
The son grants his widowed mother a life interest within, say, three months after the testator's death, with reversion to him on the mother's death.
On the widow's death, assuming son X survives, no inheritance tax is due because of the reverter to settlor exemption (section 54(1), (2) and (3), Inheritance Tax Act 1984). There should be no capital gains tax, because on the widow's death the main residence exemption applies (section 225, Taxation of Chargeable Gains Act 1992), assuming the property and its grounds fully qualify for the relief.
It should be noted that under section 73(1)(b), Taxation of Chargeable Gains Act 1992 to benefit from the capital gains tax market value uplift, the property must remain settled when it reverts to settlor. The solution is for the settlor's reverter to be by way of a life interest plus power to advance to him and others. Furthermore, in the testator's will or even letter of wishes, any specific wish regarding the above should not be expressed because inheritance tax under section 143, Inheritance Tax Act 1984, the settlement could be treated as made by the testator not the son.
Proposal 3
If the home is the main asset in the estate of the first spouse to die – say the husband, he could gift the nil rate band in his will as a monetary legacy to chargeable parties by use of a mini discretionary trust (so as not to waste the nil rate band: currently £234,000 x 40 per cent = £93,600). The residue (in particular, the home) is left to the widow. The nil rate band gift would be satisfied by a charge (or loan) on the property in favour of the trustees of the mini discretionary trust (who are likely also to be the executor/trustees of the will). That charge could be on favourable terms for the widow, for example, free of interest and deferred as to payment of the capital, albeit preferably, payable on demand by the trustees. The charge should then be a deduction from the widow's estate on her death and she would have had use and occupation meanwhile. It is important that the trustees should be specifically authorised in the will to allow the charge to be free of interest and to defer calling in the capital (thus permitting the payment of the legacy of the discretionary trust to be deferred), and notwithstanding that one of the trustees is the beneficiary of the home. A problem can arise preventing the deduction of the charge if the widow had made substantial gifts to her husband – see section 103, Finance Act 1986. In that case consider giving the widow only a life interest, and arranging for the trustees of the life interest to effect the charge.
Dangerous arrangements
Widow as beneficiary
It can be dangerous to use a discretionary trust with the widow as a beneficiary. The Capital Taxes Office is likely to treat that beneficiary as having an interest in possession in the property (see Statement of Practice 10/79).
A possible better alternative might be not to make the widow a beneficiary, so that she only occupies the property as licensee or by virtue of her own ownership of a share in the home. However even this has dangers, because the widow could be a de facto beneficiary, and the trustees could be in breach of trust.
Alternatively, the trustees could be given power to grant a tenancy to the surviving spouse at a rent which need not be arm's length, and which should not create an interest in possession. The tenancy must not be for life, and could be periodic. This tenancy arrangement will not have the advantage of the capital gains tax private residence exemption, e.g. if the home is sold in the surviving spouse's lifetime.
Joint names
It can also be dangerous for the home to be in joint names, coupled with a declaration providing that no sale can occur without consent of both joint owners or the survivor. The Capital Taxes Office takes the view that the effect of this veto is to give the surviving spouse an interest in possession under section 43(2) (see Practical Tax Lawyer 1994 at page 18). However, contrary views have been expressed.
Informal trust for the surviving spouse
In Commissioners of Inland Revenue v Lloyds Private Banking Ltd [1998] STC 559, not surprisingly, the High Court reversed the Special Commissioners' decision, in favour of the Revenue.
The facts were that Mr and Mrs E owned their matrimonial home as tenants in common in equal shares. Mrs E died and under her will left her share to her daughter absolutely, but subject to the trust and provisions that while Mr E remained alive and subject to various conditions as to payment by him of defined outgoings, 'my trustees shall not make an objection to (my husband's) residence and shall not disturb or restrict it in any way and shall not take any steps to enforce the trust for sale' of the property.
Mr E continued to occupy the home until his death and the Capital Taxes Office then also assessed the value of Mrs E's half share as constituting the termination of an interest in possession made under section 43, Inheritance Tax Act 1984. The Special Commissioner had allowed the trustees' appeal on the basis that Mr E only occupied by virtue of his own half share notwithstanding the terms of Mrs E's will.
It was held by Mr Justice Lightman in the Chancery Division that the Revenue's contention was correct: Mrs E's will did confer a determinable life interest in her half share which terminated on Mr E's death and on which inheritance tax was payable by the trustee bank. '[Mr E's] own rights as tenant-in-common were not enough to entitle him to exclusive occupation of the property...' It was not a valid argument that the relevant terms of Mrs E's will were merely 'a set of administrative directions'.
It must therefore be concluded that any type of entitlement to occupy is dangerous for the estate owner, even a de facto occupation. The solution may well be to adopt an arrangement as in Proposal 1 or 2 above.
Disclaimer for surviving spouse
To enable a surviving spouse to be in a position to disclaim his or her interest in the home effectively for inheritance tax, i.e. not having received any benefit, the idea should be considered of making a gift of the home conditional on surviving the testator for the maximum period, i.e. six months from the testator's death.
Ralph P Ray is a tax consultant with Wilsons of Salisbury.
Tax efficient will planning in relation to the family home is examined by Ralph P Ray FTII, BSc(Econ), TEP, solicitor.
The matrimonial home is one of the assets that can be used to ensure that each spouse has assets of the value of the nil rate band. This can be achieved by placing the asset either into the sole name of one spouse or into joint names as tenants in common depending upon circumstances. As regards the holding of land and building in joint names, there are two alternatives:
joint tenants; or
tenants in common.
Where property is held as joint tenants, the survivor takes absolutely and by operation of law. Hence it is impossible to make testamentary or lifetime dispositions to third parties (in the absence of a deed of variation). By contrast in the case of a tenancy in common, disposals of one spouse's or co-owner's shares during lifetime or by will are possible, e.g. to children, and hence this method of holding is generally to be recommended as affording greater flexibility. In particular as a tenant in common of part, a co-owner, e.g. a widow, would be entitled to occupy the whole (but see reference to Lloyds Private Banking Ltd below). On her death, moreover, her share would be eligible for a discount of between ten per cent to 15 per cent (see Dymond Capital Taxes page 23.520).
There are, however, two possible danger areas:
the loss on the creation of such an interest would be greater and taxed at that time. For example, father A transfers his house into joint names of himself and his son. Before the transfer, the house was worth, say, £200,000; afterwards A's half share is worth, say, £90,000. On the consequential loss formula A's transfer of value is £110,000;
the other co-owner(s) may be able to force a sale as the house would be held on trust for sale, sections 34 and 35, Law of Property Act 1925. This danger has diminished since 1 January 1997 because under section 5 of and Schedule 2 to the Trusts of Land and Appointment of Trustees Act 1996, there is no longer a duty to sell, and the trustees have a statutory power to postpone sale.
In cases where the property is held as joint tenants, but it would be preferable for it to be held as tenants in common, it is a relatively simple matter to sever the joint tenancy to make it into a tenancy in common.
If an individual, for instance, a widow, is given any right to occupy the matrimonial home, this will normally constitute an interest in possession, so that the same inheritance tax will be payable as if the house had been given outright. If the interest terminates more than seven years before the individual's death, a potentially exempt transfer will arise at that time and the seven-year period will have been satisfied. In order to avoid this, any such occupation must be informal, for instance, by way of a non-enforceable licence or permission (there should be no gift with reservation problem, because the donor is the deceased who cannot by definition have reserved a benefit, and because inter-spouse gifts are outside the gift with reservation provisions). See Sansom v Peay [1976] 3 All ER 375 and Inland Revenue press release dated 15 August 1979 referring to Statement of Practice 10/1979.
Sufficient security of tenure is likely to exist in practice if the surviving spouse is an executor or executrix of the will.
If the testator owns the entire home and wishes to leave most of the value in it to a chargeable party, e.g. his son, yet enable his widow to occupy the house without retaining a life interest in the whole chargeable on her death, he could consider giving the widow, say, a 25 per cent tenant in common share, with 75 per cent to the son. The widow would then be able to occupy the whole property by virtue of her 25 per cent tenancy in common. There must not be a bar against the son occupying as co-owner, as such a bar would give the widow an interest in possession in the whole; and see the Lloyds Private Banking Ltd case below. This can be adapted further as follows.
Recommended routes
Proposal 1
(See also 'The Principal Private Residence Part I' by James Kessler in Taxation Practitioner dated November 1990.)
The following situation can satisfactorily be achieved by the use of a flexible life interest in favour of the surviving spouse (assuming that the husband/testator owns the home – or a share in it – and leaves a widow). The relevant steps would include the following:
the will establishes a flexible life interest of the whole home (or share) in favour of the widow in the testator's will;
after the testator's death, the trustees (of whom the widow could possibly be one – but see below) appoint, say, 75 per cent of the life interest (i.e. income/occupation entitlement) in favour of the children, the trust remaining subject to the wide overriding powers of appointment;
the widow remains in occupation, although not exclusively, i.e. the children must not be barred from occupying the home as well if they wish, (a professional trustee may wish to be armed with an indemnity from the children);
the widow and other co-owners could be given an option to acquire the other's interest at market value by way of first refusal. This will help if a co-owner wishes to force a sale – a danger reduced by section 5 of, and Schedule 2 to, the Trusts of Land and Appointment of Trustees Act 1996 – see above;
requiring the widow (or other co-owner's) consent to a sale is not recommended as it may constitute an interest in possession;
the trustees should consider receiving an indemnity from the children that the widow need pay no rent.
The advantages of this approach include:
the inter spouse exemption on the husband's death on the whole property (section 18, Inheritance Tax Act 1984);
the termination of the widow's full life interest in whole or part, e.g. 75 per cent, is a potentially exempt transfer;
the gift with reservation rules should not apply because as a co-owner the widow is by law entitled to occupy the whole, and also because the termination is not 'a disposal by way of gift' under section 102, Finance Act 1986 by the widow – but an act of the trustees – a deemed transfer of value – (for this reason it is somewhat safer if the widow is not a trustee);
with regard to capital gains tax, if the property is sold at any time during the widow's lifetime (or three years thereafter), capital gains tax private residence exemption should be available by virtue of section 225, Taxation of Chargeable Gains Act 1992 – as the widow is 'entitled to occupy it under the terms of the settlement'; and as a co-owner (whether as joint tenant or the recommended tenancy in common) the widow is entitled to occupy the whole of the home, even though she is not solely entitled to occupy. By virtue of section 94(2), Finance Act 1991, the widow would not necessarily have had to so occupy the home during the 36 months prior to the sale.
Proposal 2
The testator leaves the home (or his share of it) and possibly other assets, for instance, shares of residue, to son X.
The son grants his widowed mother a life interest within, say, three months after the testator's death, with reversion to him on the mother's death.
On the widow's death, assuming son X survives, no inheritance tax is due because of the reverter to settlor exemption (section 54(1), (2) and (3), Inheritance Tax Act 1984). There should be no capital gains tax, because on the widow's death the main residence exemption applies (section 225, Taxation of Chargeable Gains Act 1992), assuming the property and its grounds fully qualify for the relief.
It should be noted that under section 73(1)(b), Taxation of Chargeable Gains Act 1992 to benefit from the capital gains tax market value uplift, the property must remain settled when it reverts to settlor. The solution is for the settlor's reverter to be by way of a life interest plus power to advance to him and others. Furthermore, in the testator's will or even letter of wishes, any specific wish regarding the above should not be expressed because inheritance tax under section 143, Inheritance Tax Act 1984, the settlement could be treated as made by the testator not the son.
Proposal 3
If the home is the main asset in the estate of the first spouse to die – say the husband, he could gift the nil rate band in his will as a monetary legacy to chargeable parties by use of a mini discretionary trust (so as not to waste the nil rate band: currently £234,000 x 40 per cent = £93,600). The residue (in particular, the home) is left to the widow. The nil rate band gift would be satisfied by a charge (or loan) on the property in favour of the trustees of the mini discretionary trust (who are likely also to be the executor/trustees of the will). That charge could be on favourable terms for the widow, for example, free of interest and deferred as to payment of the capital, albeit preferably, payable on demand by the trustees. The charge should then be a deduction from the widow's estate on her death and she would have had use and occupation meanwhile. It is important that the trustees should be specifically authorised in the will to allow the charge to be free of interest and to defer calling in the capital (thus permitting the payment of the legacy of the discretionary trust to be deferred), and notwithstanding that one of the trustees is the beneficiary of the home. A problem can arise preventing the deduction of the charge if the widow had made substantial gifts to her husband – see section 103, Finance Act 1986. In that case consider giving the widow only a life interest, and arranging for the trustees of the life interest to effect the charge.
Dangerous arrangements
Widow as beneficiary
It can be dangerous to use a discretionary trust with the widow as a beneficiary. The Capital Taxes Office is likely to treat that beneficiary as having an interest in possession in the property (see Statement of Practice 10/79).
A possible better alternative might be not to make the widow a beneficiary, so that she only occupies the property as licensee or by virtue of her own ownership of a share in the home. However even this has dangers, because the widow could be a de facto beneficiary, and the trustees could be in breach of trust.
Alternatively, the trustees could be given power to grant a tenancy to the surviving spouse at a rent which need not be arm's length, and which should not create an interest in possession. The tenancy must not be for life, and could be periodic. This tenancy arrangement will not have the advantage of the capital gains tax private residence exemption, e.g. if the home is sold in the surviving spouse's lifetime.
Joint names
It can also be dangerous for the home to be in joint names, coupled with a declaration providing that no sale can occur without consent of both joint owners or the survivor. The Capital Taxes Office takes the view that the effect of this veto is to give the surviving spouse an interest in possession under section 43(2) (see Practical Tax Lawyer 1994 at page 18). However, contrary views have been expressed.
Informal trust for the surviving spouse
In Commissioners of Inland Revenue v Lloyds Private Banking Ltd [1998] STC 559, not surprisingly, the High Court reversed the Special Commissioners' decision, in favour of the Revenue.
The facts were that Mr and Mrs E owned their matrimonial home as tenants in common in equal shares. Mrs E died and under her will left her share to her daughter absolutely, but subject to the trust and provisions that while Mr E remained alive and subject to various conditions as to payment by him of defined outgoings, 'my trustees shall not make an objection to (my husband's) residence and shall not disturb or restrict it in any way and shall not take any steps to enforce the trust for sale' of the property.
Mr E continued to occupy the home until his death and the Capital Taxes Office then also assessed the value of Mrs E's half share as constituting the termination of an interest in possession made under section 43, Inheritance Tax Act 1984. The Special Commissioner had allowed the trustees' appeal on the basis that Mr E only occupied by virtue of his own half share notwithstanding the terms of Mrs E's will.
It was held by Mr Justice Lightman in the Chancery Division that the Revenue's contention was correct: Mrs E's will did confer a determinable life interest in her half share which terminated on Mr E's death and on which inheritance tax was payable by the trustee bank. '[Mr E's] own rights as tenant-in-common were not enough to entitle him to exclusive occupation of the property...' It was not a valid argument that the relevant terms of Mrs E's will were merely 'a set of administrative directions'.
It must therefore be concluded that any type of entitlement to occupy is dangerous for the estate owner, even a de facto occupation. The solution may well be to adopt an arrangement as in Proposal 1 or 2 above.
Disclaimer for surviving spouse
To enable a surviving spouse to be in a position to disclaim his or her interest in the home effectively for inheritance tax, i.e. not having received any benefit, the idea should be considered of making a gift of the home conditional on surviving the testator for the maximum period, i.e. six months from the testator's death.
Ralph P Ray is a tax consultant with Wilsons of Salisbury.
