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Replies to Queries -- 4 -- Property relationships

27 June 2001
Issue: 3813 / Categories:

A client in his mid-seventies owns two properties which are adjacent to one another. They are joined by a double garage and shared garden. He lives in one property with a single daughter. The other property is occupied by a married daughter and her family.

A client in his mid-seventies owns two properties which are adjacent to one another. They are joined by a double garage and shared garden. He lives in one property with a single daughter. The other property is occupied by a married daughter and her family.

Our client inherited the property in 1992. In 1993, his married daughter and her family were allowed to live there and it was always referred to as their property. No rent was ever paid and they have always been responsible for the outgoings. They did not move in for about a year whilst they were extending it. At that time it was a one-bedroomed bungalow worth £55,000, but they have spent £20,000 transforming it into a three-bedroomed chalet bungalow. The husband is a carpenter and did most of the work himself. The property is now worth £200,000.

If our client transfers the property to his daughter and her husband, there will be capital gains tax repercussions and, unless he survives for seven years, there will also be inheritance tax to pay. Is it possible for the daughter and son-in-law to place a charge on the property equal to the amount of their contribution to the increase in value including the work done personally by them?

It may be possible to transfer the property into a discretionary settlement for the benefit of our client's daughters and remoter issue and to take advantage of the holdover relief by virtue of section 260, Taxation of Chargeable Gains Act 1992.

The property in which our client lives is also worth £200,000 and I have advised that under section 102B, Finance Act 1986 he could gift a substantial share in that property to the daughter who lives with him, provided that she paid the appropriate share of the outgoings. This would save inheritance tax provided he survived for seven years.

We would appreciate readers' views.

(Query T15,831) – D.C.

 

With regard to the single daughter, the arrangements proposed only qualify for so long as both parties remain in occupation and it will normally only work on a 50/50 split basis.

The problem to which the father should address his mind is that if, for some reason not currently anticipated, the daughter moved out of the property, section 102B(3)(b), Finance Act 1986 would oblige him to pay her full consideration for the use of her half share. Experience suggests that the District Valuer will be instructed to contend for half the open market rental. This could be substantial and would have to be funded out of after-tax income.

Gifting the property occupied by the married daughter and her family gives rise to a number of problems:

(1) In order to avoid a dispute as to whether a reservation of benefit had been made under section 102(1)(b), Finance Act 1986, the garage and garden would either have to be excluded from the gift, or, if a gift of part of the retained property were to be made to the unmarried daughter, divided between the two properties. Section 102B(4)(b) would be difficult to comply with if this was not done in the latter event.

(2) While a non-potentially exempt transfer within the nil rate band generating a capital gains tax hold-over looks attractive, the family's continuing to live in the property is likely to be regarded by the Revenue as involving the creation of an interest in possession ab initio under Inland Revenue Statement of Practice 10/79, with the result that the transaction would be looked at as a potentially exempt transfer, without the possibility of a hold-over.

(3) The problem about the married daughter and her husband having spent their own money on the property is that the sum expended will not be deductible by the father for the purposes of his capital gains tax computation under section 38(1)(b), Taxation of Chargeable Gains Act 1992, unless it can be established that, at the time, the expenditure was being made 'on his behalf'. This would have to be established by contemporaneous evidence. In the absence of such evidence, it would not be possible for the daughter and son-in-law to be given a mortgage for an equivalent amount without it being regarded as a gift, and (necessarily) a gift with reservation.

An examination of the circumstances leading up to the carrying out of the works might, however, give rise to a situation in which the daughter and son-in-law would (in the event of a family dispute arising) be entitled to protect their investment in the property through the defensive mechanism of proprietary estoppel. The leading case on this is Inwards v Baker [1965] 2 QB 29. For valuation purposes, the father's freehold interest would be depreciated by such rights, albeit those which would be personal to the daughter and son-in-law and extremely difficult to estimate in the absence of litigation (because most of these cases involve a mother-in-law expending her life savings financing the erection of a granny annexe). The advice of Chancery Counsel would be required both to establish the applicability of the doctrine to the facts in this case and the degree of protection which a court would be likely to afford.

On the face of it, an opportunity may exist for both a capital gains tax disposal to be made and a potentially exempt transfer to be fixed at a favourable value. That said, the effect of proprietary estoppel rights on the fiscal situation is uncertain because no court has had the opportunity to consider the issue either for capital gains tax or for inheritance tax and, in particular, whether and in what circumstances the beneficiaries of proprietary estoppel could be said to have an interest in possession in the property. If that were to be the case, then section 49(1), Inheritance Tax Act 1984 would deem them already to have an interest in possession in it. – WJdeS.

 

Although it is not normally possible to acquire an interest in land without a written agreement, there is an exception to that rule under the doctrine of proprietary estoppel. If a person acts to his detriment, for example by incurring work or expenditure on improving a property with the expectation and assurance that he will receive an interest in the property as a result, equity steps in to grant him such an interest: see for example the recent decision of the Court of Appeal in Gillett v Holt [2001] Ch 210. We do not have sufficient information to say whether any expectation was created and, if so, of what nature, but it may be that the daughter is entitled to a share of the property.

If no proprietary estoppel claim arises, the alternative approach is for the client to transfer the property into a discretionary trust. The benefit of this would be the availability of holdover relief under section 260, Taxation of Chargeable Gains Act 1992. Although this will make the transfer chargeable for inheritance tax purposes, the transfer will be within the nil rate band, so there will be no tax to pay. The capital gain that arises on the transfer can be held over. The subsequent disposal of the property will be exempt if the trustees allow the daughter to occupy under an express power (section 225, Taxation of Chargeable Gains Act 1992 and Sansom v Peay [1976] STC 494).

Finally, 'D.C.' has advised that his client could gift a substantial share in the property in which he resides to the daughter who lives with him. 'D.C.' is correct in his/her analysis that this would avoid an inheritance tax charge provided that the client survived for seven years after making the gift. No reservation of benefit would arise by his remaining in occupation as long as his daughter also continues to reside there (section 102B, Finance Act 1986). He can gift as large a share as he wishes to the daughter so long as the outgoings that she meets on the house are in proportion to her share on the property. Otherwise he will be deemed to have received a benefit and the property will be treated as forming part of his estate immediately before his death. – Portia.

Extract from reply by 'Robin Hood':

As to the property in which the married daughter lives, the client could consider creating a separate title over the property plus, say, half the garden and one garage. The client would then execute a declaration of trust to confirm that he held the property on trust as to X per cent for himself and Y per cent for his daughter and son-in-law. Equity will recognise the contribution of the daughter and son-in-law. Professional advice would need to be taken from a chartered surveyor in determining X and Y. The idea would be to confirm the daughter and son-in-law's contribution rather than make any gift to them. A declaration of trust might be preferable to the children trying to place a charge on the property. The chartered surveyor would need to be instructed how to assess X and Y. Ordinarily, what was spent by the daughter and her husband would be pro-rated with the starting value of the property as proportions of the new value. Here, a reasonable way to deal with it would probably be to instruct the chartered surveyor to determine what the bungalow would now be worth in its existing state, i.e. what would the £55,000 bungalow currently be worth, and make that X per cent belonging to the client. The balance would be Y per cent belonging to the daughter and son-in-law. Possibly some adjustment might be made for the absence of rent.

Editorial note. In Gillett v Holt a landowner repeatedly over many years promised his farm manager that he would succeed to his farm business. However, in the course of time the two fell out and the landowner made other arrangements for succession to the business. It was held that the landowner's conduct had given risen to an estoppel and the farm manager should receive compensation.

Issue: 3813 / Categories:
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