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 March 2003. Older articles are accessed through our main Property Tax page.

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Isis Financial Planners offers tax planning advice as well as a Tax Self Assessment Service.

My husband and I live in a property worth about £300,000. We intend to leave it to our children. How can we avoid paying inheritance tax?

Maggie Fleming writes:

You say nothing about your other assets or whether you hold the property jointly and, if so, whether as joint tenants or tenants in common. Consult a solicitor for advice on your precise circumstances.

Inheritance Tax is levied on estates above £250,000 and husband and wife are treated separately. If the house is your major asset, you can avoid an inheritance tax liability by owning the house as tenants in common and each writing a will that leaves your half share to your children. If you are currently joint tenants (which is the usual situation), the joint tenancy will need to be severed. However, this is a simple and cheap procedure that can be easily arranged by your solicitor.

While this would solve the problem, you need to think about the practical consequences of willing half the property away from the surviving spouse. What if he or she needed to raise capital, or there were a family quarrel, or one of your children were to become bankrupt or get divorced? Talk these issues over with your solicitor, who may be able to suggest solutions - a simple trust structure may provide protection for the survivor.

There are more sophisticated schemes on the market but they are expensive and unproven in the courts, Also, if the house is your major asset, you may find that the legal fees involved would not be that much less than the tax at stake especially if house values come down in the future.

When we have sold our current house, we would like to pay off our daughter's mortgage. Is there any reason why we can't live her an "interest-free" loan to do this?  We l1Jould 1Wt expect her to pay us back.

Maggie Fleming writes:

If you don't want the money back, why not just gift it? Provided that you both survive for seven years after the gift, it will be a PET (Potentially Exempt Transfer) under current legislation and not liable to Inheritance Tax (IHT). After seven years, the money will have fallen out of your estate and will not be liable to Inheritance Tax on your death. A loan, on the other hand, would form part of your estate.

If you or your spouse die within the seven years, your daughter would have some tax to pay on the gift if either of your estates, plus the gift, were in excess of the £250,000 nil rate band. The amount of tax payable in those circumstances would be based on a sliding scale, with proportionately more tax payable if you died within three years of making the gift than if you were to die five or six years later. If this is a concern, and you are in good health, it would be possible to effect a seven-year decreasing term life assurance policy to cover the risk.

Each year, just before the Budget, tax advisers warn their clients that this could be the Budget where the Chancellor abolishes PETs and reinstates the old Capital Transfer Tax rules under which lifetime transfers were taxable. Even if this were to happen in the upcoming Budget, however, it would not affect you if the gift were within your nil rate bands.

We live in a farmhouse on a working farm. We want to develop a large oast house in the farmyard, then let out one of these houses and live in the other. We will probably want to sell both houses and farm and retire in 10 years. How could we organise living arrangements to take maximum advantage of Capital Gains Tax (CGT) exemption on principal private residence? Should we live in one, then sell it and move into the other and then sell that? Ideally, we would like to retain ownership/control over both until we decide to sell up.

Maggie Fleming writes:

If each property is, at some stage in your ownership, your main residence, each will qualify for a measure of principal residence relief on sale. In particular, the final three years of ownership would be treated as exempt, as would up to a further £40,000 if you had also let the property at some point. Clearly, this is an extremely generous relief and the Inland Revenue will look carefully at cases where it feels people may be manipulating the facts in order to claim the relief.

In extreme cases, the Revenue can deny relief on the grounds that someone bought or developed a property with the intention of making a gain on its sale. Or it could treat the gain as a trading profit rather than as a capital transaction. This is unlikely in your circumstances, as you will be keeping the property for 10 years prior to sale but you should discuss this with your accountant.

If you live in the oast house with the genuine intention of making it your home and nominate it as your main residence, relief should be due. Relief will also be due on the farmhouse, as it has been your main residence to date. Even after all reliefs, there may be a chargeable gain on sale of the oast house - if so, you may wish to sell it in a different tax year from the other sales in order to use up your annual exemption. If you are married, you and your spouse should hold the property jointly.

I am wondering what happens to people who inherit houses above the tax threshold of £250,000. In such circumstances, is a person obliged to sell in order to pay inheritance tax (IHT), or is there another way of anticipating events?

Maggie Fleming writes:

The personal representatives are responsible for paying the tax due on the value of the deceased’s estate – this will be 40 per cent on the excess over the nil rate band (currently £250,000). Where the estate consists of an expensive property but little else, this may result in the house having to be sold in order to meet the inheritance tax bill. This only applies where the property is left to someone other than the spouse as transfers between husband and wife are exempt from tax.

In the case of real property, the personal representatives can elect for payment by 10 equal, yearly instalments. Choosing this option may make it feasible to hold on to the house. The Inland Revenue will, of course, charge interest on the unpaid instalments.

The alternative is to persuade the deceased, while still hale and hearty, to bring into effect a life insurance policy which will pay out sufficient money on death to meet the expected inheritance tax liability. The policy should be written under trust, so that the proceeds do not themselves form part of the chargeable estate and are not therefore liable to inheritance tax. The other advantage to writing a life policy under trust is that the proceeds can be paid quickly to the intended beneficiary, as they do not have to wait for probate.