Property and Tax Issues

Isis' Maggie Fleming answers readers questions in Saturday's Daily Telegraph newspaper for the Property Clinic section.

The questions and answers are reproduced for you here.

This page contains Questions & Answers from February 2005. Older articles are accessed through our main Property Tax page.

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My wife and I recently changed from being beneficial joint tenants to tenants in common. Our property is valued at £300,000. Our wills state that we leave everything to each other, and on the second death the remaining assets are to be shared between our nine children.

As our total assets will exceed our combined Inheritance Tax (IHT) allowances, and on the first death half of the property is willed to the other - rather than passing automatically, as it would as beneficial joint tenants - will this mean that the first person will have fully used his/her IHT allowance, therefore reducing the tax liability on the second death? If this is not possible, what other means can be utilised to achieve the desired effect?

Maggie Fleming writes:

The first step towards mitigating IHT is often for a husband and wife to sever a joint tenancy and become tenants in common. But the point of doing this is so that the first to die can leave his/her share of the property to someone other than the surviving spouse. If you leave it to the spouse, the legacy is exempt from IHT and the first to die will not have used his/her IHT nil-rate band. As the wills stand, the IHT bill will be the same as if you hadn't become tenants in common.

You need to take the next step: change your wills so that a share of the property goes to the children on the first death in order to use up as much as possible of the nil-rate band. There can be dangers with such a legacy - family disputes or legal problems if one of your brood gets divorced or becomes bankrupt. Discuss the options fully with your solicitor. Possibly, the children could be persuaded to create a "revertor to settlor" trust on the first death to give the surviving parent security.

Alternatively, your solicitor may be able to suggest IHT planning, using a nil-rate band discretionary trust. You should note that Stamp Duty Land Tax may become payable on the first death, where such an arrangement is entered into. The Inland Revenue takes a keen interest in this complex area, so expert advice is essential.

In 1992, with a commuted lump sum from my occupational pension, we purchased a two-bed flat for £50,000, to let for rent. It is lawfully owned by my wife and son under a trust deed with a solicitor. It brings in about £2,500 per annum net each. All income is declared and accepted by the relevant Inland Revenue offices.

My son has completed a degree course and is entering the paid workforce. How can his share of rent be reduced/shifted so that his mother, who is not earning, may benefit up to her full personal allowance? The current value of the flat is about £160,000. Also, can he give tax-free gifts to her over a period of time?

Maggie Fleming writes:

While it is normal for the income received from an asset to reflect the shares in which it is owned, this does not have to be the case. Provided the joint owners are not husband and wife (where special rules apply), they may agree on a different division of profits and losses. I recommend that you get any such agreement drawn up formally by a solicitor.

I am not sure what you have in mind by "tax-free gifts". Which tax? You may be thinking of the particular case of your son gifting a further share of the property to your wife. In that situation, he could gift a portion that produced a gain just below the annual Capital Gains Tax (CGT) exemption (currently £8,200). But is it really sensible for him to make such gifts to his mother? In Inheritance Tax (IHT) planning, it makes sense for the older generation to pass assets to their children, not the other way round.

There is nothing to stop your son making gifts out of taxed income to his mother. These would not normally have any taxation consequences. From an IHT point of view, an individual can make use of the annual £3,000 exemptions, and gifts in excess of this amount will be Potentially Exempt Transfers (PETs) in any case, only chargeable to IHT if the donor dies within seven years with an estate worth more than the nil rate band (currently £263,000).

I am writing to ask your advice regarding the pre-owned assets legislation due to take effect in April. My wife and I bought a house in Swansea in 1989 for £49,000 and about 1993 transferred the ownership to my son and daughter (now aged 41 & 43 respectively), when the value was in the region of £53,000. This transfer was in name only as my wife and I have paid for all the upkeep, household bills and maintenance. We have never paid any rent nor have the children incurred any costs with regard to the house.

The only reason that I transferred the house was to make it much easier to get probate granted when there was no property involved.

In 2000, at our request, they sold this house for £65,000 and bought our present address for £59,000. The balance was used to pay estate agents' fees, solicitors, moving expenses etc. The rest of the money was spent on refurbishing the house, which was in a very bad condition. I estimate the house is now worth about £150,000, but this, with my other assets, does not bring my estate to the threshold for inheritance tax (IHT).

Will I now be liable to pay tax, and if so, how can I legally avoid doing so? I have discussed this with my children and they have agreed that if necessary they will give me back the house. I have seen somewhere that if I inform the Inland Revenue that the house is still part of my estate, this might be the answer.

Maggie Fleming writes:

The Government introduced the pre-owned assets provisions in order to plug what they saw as loopholes in the IHT "gifts with reservation of benefit" rules. Having said that, the new rules are unlikely to affect you, as, from what you have said, it would appear that you are caught by the old rules. You gave your home away but continued to live in it and this is a straightforward reservation of benefit. Even the move into the new property does not affect this, as the new house will be regarded as a substitute for the old one.

As matters stand, the property will be treated as part of your estate on your death and there is therefore no need for you to take any special measures to avoid the pre-owned assets charge.