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Replies to Queries - 2 - Happy families

14 November 2001
Issue: 3833 / Categories:

If parents sell their home for full value to their children, the children raising a mortgage, and the parents paying a full rent, this appears to avoid any reservation of benefit from the point of view of inheritance tax.

Is the position compromised, however, if the parents leave the full consideration from the children on mortgage, charging a commercial, or a low rate of interest, or no interest?

If parents sell their home for full value to their children, the children raising a mortgage, and the parents paying a full rent, this appears to avoid any reservation of benefit from the point of view of inheritance tax.

Is the position compromised, however, if the parents leave the full consideration from the children on mortgage, charging a commercial, or a low rate of interest, or no interest?

As there has not been a gift, is there a reservation of benefit if the children do not charge rent, albeit the parents will have no security of tenure?

(Query T15,909) – Big House.

 

It is true that there cannot be a gift with reservation if there is no gift. The Revenue could only put the house back into the parents' estate by arguing that:

* the whole arrangement is in fact a 'sham' – that it has not been properly carried out; or

* there is an element of gift in the transaction – it would be very important that the value ascribed to the property, and reflected in the consideration, is defensibly its full market value.

If there is any element of gift, there is an argument that the gifts with reservation rules can pull back the whole of the asset into the donor's estate – there is no proportionality about it. A small reservation has as much effect as a large one.

The next question is whether there are any other problems with the scheme. 'Big House' has already raised one: the parents are now living in a house which they do not own, exposed to the possibility of falling out with their children, or their children's bankruptcy or death. This is not satisfactory, but most attempts to give them security will cause further problems.

Another problem is the outstanding 'mortgage', which is an asset of the parents' estates – only the growth in value of the house after the transaction is to be excluded using this arrangement. This growth in value is then exposed to capital gains tax, because the only or main residence exemption is not available to the children if they are not living in the house. Taper relief will eventually reduce this below the level of the inheritance tax that might otherwise have been payable, but it should be taken into account. This arrangement does not make the whole value of the house 'disappear' from the charge to capital taxes.

One possibility which preserves security and tax exemptions (but could perhaps be attacked by the Revenue) is for the children to put the house into a trust for the parents for life, with reverter to settlor. The trust enjoys the capital gains tax exemption because the property is occupied by beneficiaries of the trust, and the reverter to settlor on death is exempt from inheritance tax on the beneficiaries' deaths under section 54, Inheritance Tax Act 1984. However, the Revenue might regard the succession of transactions as something that it could attack – the sale for an IOU, the return by settlement, and the eventual reversion. Even if such an attack might not succeed, the argument might be more trouble than it was worth. – Gardener.

 

Section 102, Finance Act 1986 provides that for the reservation of benefit rules to operate there first has to be a 'gift'; it follows that if the arrangements are based on a bona fide commercial sale, the reservation of benefit rules do not come into play on that sale.

However, it needs to be appreciated that the immediate inheritance tax implications of such a sale are neutral; the parents have replaced one asset – their home – with another of equivalent value – the proceeds of the property sale or the benefit of the loan to the children. The intention behind the suggested arrangement is to place the potential for future growth in the value of the property into the hands of the children and so away from charge to inheritance tax in the estates of the parents.

It does seem that such partial inheritance tax mitigation comes at a cost:

(i) Ad valorem stamp duty would be payable on the sale by the parents.

(ii) Although capital gains tax main residence relief should be available to the parents on the sale to the children, future increases in value, whilst saved from inheritance tax, would ultimately be taxable in the hands of the children for capital gains tax purposes, and the opportunity lost to obtain the tax-free uplift on the parents' deaths. It may of course be that on a future disposal a child would himself qualify for main residence relief, absent which proactive planning for the gain on a future disposal would need to be considered.

(iii) Security of tenure issues are a vital consideration for the parents; the parents retain no proprietary interest in the property, and so lose any occupation safeguards otherwise available to them under, for example, the Trusts of Land and Appointment of Trustees Act 1996. Whilst the parents may have complete trust in their own children, later business or matrimonial difficulties experienced by a child or a premature death could involve the property, or a share in it, falling into the ownership of a far less magnanimous third party. The parents would also have to consider how they stand if they wished to move house.

The security of tenure drawbacks might be addressed in part by the parents using the sale proceeds to fund payment of a full market rent to the children, always keeping in mind that the purpose behind the exercise will be defeated if, in addition to the proceeds of the property sale, the parents acquire another interest in the property through their tenancy/lease; whilst payment of a full market rent by the parents is not required for inheritance tax purposes, those funds might be used by the children to service the interest due on a mortgage taken by them to purchase the property from the parents.

There is no reason why the parents should not leave the sale price outstanding on loan to the children, and, indeed, there is something to be said for such an arrangement in giving the parents the option subsequently to release the loan as a potentially exempt transfer or perhaps in stages to use annual inheritance tax exemptions.

Were the parents minded to make the loan to the children at less than commercial interest or interest-free, then provided that the loan was expressed to be repayable on demand, there will not have been any diminution in the value of the parents' estate. Further it is suggested that any attempt to argue that the failure to charge interest represents a waiver of interest so requiring treatment, as a succession of gifts made over the duration of the loan would be entirely misconceived as a matter of property law. – Digby Bew.

 

Editorial note. Writing off the loan in stages would be vulnerable to the associated operations provisions of section 268, Inheritance Tax Act 1984. Even so, the operations remain potentially exempt.

Issue: 3833 / Categories:
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