Replies to Queries - 3

Family home

With the recent property boom, London property values have more or less doubled in the last four years. One of my clients has a property which is now valued at around £450,000. He and his family have occupied the property as their principal private residence and therefore, with the capital gains tax exemption, the only possible tax implication is the potential inheritance tax charge.

The problem is that the property is in the sole ownership of my client. He is not interested in any form of trust arrangements, but ultimately he wishes to pass the property down to his six children.

Would the simple act of transferring the ownership into joint names, followed by a gift of their shares (50 per cent each), on their respective deaths, to their children, ensure that each spouse ends up utilising their nil rate tax band? With this limit currently at £250,000, the inheritance tax exposure is eliminated.

Can readers comment on the viability of this idea with due regard to legal and inheritance tax issues? What can be done to protect the surviving spouse's continued occupation of the home?

(Query T16,154) - Nil rate.

The husband gifting half the beneficial ownership to the wife is a starting point for inheritance tax mitigation. Assuming the property to be free of mortgage, there will be no stamp duty payable on the Land Registry Transfer. Of itself, this does not achieve any value reduction on the first death because of the related property valuation provision (see section 161(2)(a), Inheritance Tax Act 1984). After that, provided that the half shares can be kept segregated, each will be worth 42.5 per cent of the value of the house.

The husband clearly does not wish to risk having the property sold against his opposition. However, if the transfer into joint ownership were to contain a provision requiring his consent to a sale of the house, the Inland Revenue would be likely to take the view that, after his death, section 43(2)(a), Inheritance Tax Act 1984 should be interpreted as meaning that, for the purposes of that tax, the house should be treated as 'settled' and that he had an interest in possession in the wife's former half. Under section 49(1), Inheritance Tax Act 1984, he would then be treated as if he were the absolute owner of that half, not only bringing it into charge on his death, but also eliminating the co-ownership discount on that occasion. The Inland Revenue would be able to draw on parts of the following case law for comfort in relation to this hypothesis: Lloyds Private Banking Ltd v Commissioners of Inland Revenue [1998] STC 559, Woodhall (personal representative of Woodhall) v Commissioners of Inland Revenue [2000] SSCD 558, and Faulkner (trustee of Adams deceased) v Commissioners of Inland Revenue [2001] SSCD 112.

The alternative of allowing the children absolute interests in half on the first death, unfettered by any survivor's right of veto, could not be recommended. A sale of the property would be likely to result if one of them went bankrupt or got divorced.

It also needs to be borne in mind that, if the husband survives the wife, the provisions of section 103, Finance Act 1986 will apply to disallow any debt which was owed by his estate on his death if it was generated from the gift of the half share to her. This means that the preferred method of getting round the section 43(2)(a) problem - passing the value of the half share through a nil rate discretionary trust in which the widower is a beneficiary and from which an interest free loan could be extended to him - needs to be analysed very carefully. The generally accepted view is that section 103 can be got round through the creation of an interest in possession trust in favour of the widower to which the money is lent. That view may, however, turn out to be over-optimistic if Inland Revenue Capital Taxes Office takes a test case against a subscriber to one of the settled debt schemes.

This issue apart, the loan from discretionary trust arrangement has been accepted by Inland Revenue Capital Taxes Office for the last five years, although there have recently been suggestions that this practice is under reconsideration in the context of the future of Statement of Practice, SP 10/79, 'Power for trustees to allow a beneficiary to occupy dwelling house'.

It is that Statement of Practice, combined with uncertainty, following the judgment of Mr Justice Lightman in Commissioners of Inland Revenue v Eversden (Executors of Greenstock) [2002] STC 1109, as to the extent to which sections 12, 13(7) and 22, Trusts of Land and Appointment of Trustees Act 1996 changed the general law, which makes it undesirable either:

Subject to any clarification which may emerge from the Court of Appeal in Eversden, the likelihood is that Inland Revenue Capital Taxes Office would claim that he had obtained an interest in possession under section 49(1), with the consequences considered above.

The best course of action therefore seems to be for each spouse to create a nil rate band discretionary trust by his or her will. That should contain a power to appropriate a notional asset into the trust. Subject to the section 103 complication referred to above, this would enable:

On the survivor's death, an amount equal to the nil rate band on the first death would then be deducted from the open market value of the house on the second death. - JdeS.

'Nil rate's' client can transfer a share in the property to his wife without any tax implications. It would be important that they held the property as 'tenants in common' so that the share of a deceased would pass by will, rather than accruing by survivorship as it would if they were beneficial joint tenants.

If the share is left outright to the children on the first death, there is the theoretical danger that the surviving spouse's rights of occupation could be prejudiced. If the children are outright owners of a share, they could divorce or become bankrupt and the new owner of a share might be in a position to force a sale. Or the children might simply fall out with the surviving parent!

For a time it was thought prudent for the wills to provide that no sale should take place during the surviving spouse's lifetime without his or her consent, but following the decision of Mr Justice Lightman in Commissioners of Inland Revenue v Lloyds Private Banking Limited [1998] STC 559 this type of provision is thought likely to create an interest in possession in the deceased's half share so that the whole property is taxable on the second death.

The outright gift route also has capital gains tax drawbacks. On an eventual sale, the children may be liable for capital gains tax on the increase in value of the deceased's half share between the first and second deaths unless one or more of them occupies the property with the surviving parent.

These issues could be addressed by an outright gift to the children with the hope that they would settle the deceased's share on the surviving parent for his or her lifetime with remainders back to the children designed to exploit the inheritance tax revertor to settlor exemption in section 53(3), of the Inheritance Tax Act 1984. For capital gains tax purposes, the children would need to take interests in possession in advance of becoming absolutely entitled in view of section 73(1)(b), of the Taxation of Chargeable Gains Act 1992. There is a danger of attack under section 143, Inheritance Tax Act 1984 if the children are acting in accordance with the testator's request; in that case the inheritance tax settlor would be the deceased so that the exemption would not be available on the surviving spouse's death.

A safer option is for the parents' wills to include nil rate band discretionary trusts and for provisions to be included that allow the trust to be satisfied by a debt or charge over the deceased's share in the property that would then pass to the surviving spouse under the gift of residue. Then, on the second death, a deduction should be allowed before calculating the inheritance tax, and the full value of the property should benefit from a capital gains tax-free uplift.

If it is anticipated that the property will increase in value so that it will in future exceed two nil rate bands, consideration might be given to gifting a share to those children still living at home who do not anticipate 'flying the nest' during the donor's lifetime. Provided the running costs were henceforth met in the appropriate proportions, such a gift would be outside the reservation of benefit provisions in view of section 102B, Finance Act 1986. However, such a strategy could still prejudice the survivor as described above. - Lacuna.

Extract from reply by 'N.K.':

Another suggestion is a lease for life. With the husband leaving his half share in the house to the children, the widow would sell her half share to them in consideration of a lease for life in the whole property. Equality money may have to be paid, together with ad valorem stamp duty. As the lease would have been acquired for full consideration, then it is not a statutory settlement and section 43(3), Inheritance Tax Act 1984 would not apply. Also the gift with reservation situation would be circumvented and she will be left with a depreciating asset in her estate. However, when the children presumably come to sell the property, not qualifying for principal private residence relief, they will no doubt each be faced with a capital gains tax bill, but when you divide that figure by six, it is not as bad as it originally seemed. Also, if they are all married, replace six by twelve, which is even better!

Editorial note. Despite 'Nil rate's' comment that 'he is not interested in any form of trust arrangements', many replies suggested the 'house debt scheme'. Peter Erane's article, 'As Safe As Houses?', in Taxation, 30 January 2003 at page 397, examines several aspects of these.

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