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 May 2005. Older articles are accessed through our main Property Tax page.

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My wife and I are tenants in common equally sharing assets totalling £640,000, with the house being half this sum. It is our intention on first death to leave a half-share of the house and financial assets up to the nil-rate band to our two daughters, with the residue passing to the surviving spouse, who will continue to live in the home. We are looking for occupancy protection, which I believe can be provided by a reverter to settlor trust. Do you have any details about these?

If the surviving spouse remains in the home, I presume it would be seen as an interest in possession, so rental would need to be paid. Must this come out of income? If so, can a return on asset investments be considered as income?

Finally, I understand my daughters must pay tax on the rental income received. If so, could we not make payment instead to their children through an accumulation and maintenance Trust?

Maggie Fleming writes:

I agree that using a reverter to settlor trust is ideal for your purposes and is the best way of ensuring that the surviving spouse has security of occupation. On the first death, a half share of the property passes absolutely to the children who, of their own volition, decide to create a reverter to settlor trust in favour of the survivor. It must be their decision and cannot be included in your wills.

A reverter to settlor trust is simply a form of interest in possession trust, by which the surviving spouse enjoys the right to live in the property for life. The difference is that, because the property would revert to your children on the death of the life tenant, there is an exemption which means that the value of the life interest does not fall into the estate of the life tenant on the second death.

The gift into trust by your children would be a PET (Potentially Exempt Transfer) and therefore exempt from Inheritance Tax (IHT), provided they survive for seven years after making the gift.

There is no requirement for the survivor to pay rent to the trustees.

Solicitors' costs can vary considerably and I suggest that you obtain quotations from a number of firms. When you have chosen a suitable solicitor, you should look at the Capital Gains Tax (CGT) issues also. For CGT purposes, it may be better if, instead of the property reverting absolutely to your children on the second death, the trust continues, with your daughters becoming the new life tenants.

My father died in 1995 and his will left everything to my mother, including the family home. Shortly afterwards, my mother gave me 50 per cent of the house on a tenants-in- common basis. My mother is now 85 and in very poor health and I am her carer. The house is her only major asset and is currently worth about £350,000. I am wondering what the capital gains (CGT) and inheritance tax (IHT) implications are when she dies. I have lived at home all my life and do not plan to move when my mother dies.

Maggie Fleming writes:

Neither you nor your mother's estate should have any tax to pay on her death or on any subsequent sale of the house. Although your mother has continued to live in the house after giving you a half-share, this is not a "gift with reservation of benefit" and nor is it caught by the new pre-owned assets legislation. In fact, gifting a share of your home to a child who lives with you is one of the few ways left in which to mitigate IHT on the family home.

This kind of arrangement is specifically covered by Section 102B of the Finance Act 1986. The Inland Revenue is happy with these family sharing arrangements provided that no more than 50 per cent is gifted by the parent and each party bears their own share of costs - it is particularly important that the parent pays their share of expenses.

The legislation applies to gifts made after 1999 but you are covered by a previous government statement. As the gift was made more than seven years ago, it has fallen out of your mother's estate.

Should you ever sell the house, you will have no CGT liability, as it will have been your only or main residence throughout your period of ownership and therefore attracts the principal private residence exemption.

Continuing the series in which our Clinic experts provide a guide to those thorny issues that can leave the unwary out of pocket. This week, Maggie Fleming on the effects of the Government's new pre-owned assets legislation.

It is a bit early in the morning to be grappling with financial jargon but I fear these changes will alter my tax position for the worst. Break it to me gently...

The pre-owned assets legislation which has just come into force will affect many taxpayers who have forked out substantial sums for sophisticated plans designed to reduce the Inheritance Tax (IHT) payable by their estates. The legislation will catch any such planning entered into since March 1986!

What exactly are these plans?

They take different forms but have in common the intention of side-stepping the gift with reservation rules by allowing people to give their homes away while continuing to live in them. The most common types involve either the use of double trusts or else carving a leasehold out of a freehold interest.

What should we do?

People who have these plans will need to go back to their advisers to decide whether they should unravel them and let the property fall back into the IHT net (in which case they have to make an election by January 31, 2007) or whether they should keep the IHT advantage but pay an annual income tax charge based on the rental value of the property. The decision will depend not just on the type of scheme involved but also on such factors as how long they are likely to live and how much the property might be worth when they die.

Which is the best option?

If you go for the income tax charge, you will not be paying a full rent. Instead, you will pay tax at your marginal rate on the notional rent - so a higher rate taxpayer would pay 40 per cent of the full rent. There is a limit - if the annual rental value is less than £5,000 per person, there is no income tax payable.

Does this just hit a few rich people with clever accountants?

No, it is not only those who went in for sophisticated planning who will be caught by the new rules. It used to be that you could sell your property and give the proceeds to your children. If your children used the money to buy you a new home, there were no IHT consequences. However, if you did that after March 1986 you are now caught by the pre-owned assets legislation.

Which brings us to the point that some people will not know they are caught by the legislation and the whole sorry muddle will only come to light when they die.