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Inheritance Tax: The Family Home

For the majority of us the family home constitutes our major asset and in many cases, it is also the main cause of Inheritance tax (IHT) liability arising.

With the introduction of the Transferable Nil Rate Band (TNRB) from the 9th October, essentially married couples, civil partners, widows and widowers will have 2 nil rate band (NRB) allowances and in most cases, this should be sufficient to protect the family home from IHT liability.

However, the TNRB may not always be available (i.e. partly used) and taking into account single or divorced homeowners as well as those with properties well in excess of the NRB threshold; tax planning for the family home will still be relevant in a lot of cases, especially given the fact that the continuance of the TNRB is uncertain.

PROBLEM 1:
One of the major stumbling blocks with regards to the home and IHT is the ''Gifts with Reservation of Benefit'' (GROB) loophole; where the owner of a property gifts it to someone else in an attempt to avoid it comprising part of their estate (thus no IHT ) but retains some kind of benefit from it, namely he/she still resides there despite it being held in someone else's name. The reservation as far as the HMRC are concerned is a clear indication that the property was never a gift therefore continues to be part of the person's estate for IHT purposes. 

PROBLEM 2:
Additionally, where a person gives away an asset (but most importantly the family home) and continues to retain some benefit from that asset (as shown above) there will ALSO be an income tax charge on the 'benefit in kind' known as the 'Pre-Owned Assets Tax Charge' (POA).

However, there are still some IHT avoidance/reduction methods that can be used with regards to the family home, though many will have Capital Gains Tax (CGT) implications (see Capital Gains Tax & The Family Home - yet to be updated).

PLANNING TECHNIQUES

Move Out & Give Away
If you can afford to and are willing, move out of the house, and give it away. The gift will be a Potentially Exempt Transfer (PET) thus will be exempt from IHT provided the transferor survives 7 years after making the gift.
Additionally, if you make the gift within 3 years of having moved out of the home, there will be no CGT to pay under the principal private residence relief rules.

Sell & Give Away Proceeds
If the above option is not viable for you, sell your current home, downscale and give away the surplus cash from the sale. Again, the gift of the surplus cash will constitute a PET; if you survive 7 years after making he gift, it will be IHT exempt.
A more adventurous approach would be to give away ALL the sale proceeds, and move into rented accommodation.

WARNING: Whilst this strategy is good IHT planning, it does not provide much security for you in your old age and might prove problematic with the local authorities if you end up needing to go into a care home.

Re-Mortgage & Give Away Proceeds
Another way of extracting most of the value of your home out of your estate if you still wish to remain there, is to re-mortgage the property then give away/spend the borrowed funds. The outstanding balance of the mortgage will be deducted from your estate when you die, thus reducing/eliminating IHT AS LONG AS the borrowed funds have been spent before you die, or have been given away in full and you survive 7 years after making the gift.

WARNING: A disadvantage to this approach is that the mortgage debt will need to be serviced from your retirement income.

Re-Mortgage & Buy an Annuity
Fine-tuning the above approach would be to buy an annuity with some/all of the re-mortgage proceeds which will enable you to service the debt and give away/spend any surplus.

WARNING: A drawback with this approach is in the event of a premature death after purchasing the annuity, a lot of the property's value will have been lost to the annuity provider.

Sell/Re-Mortgage & Invest Proceeds
Perhaps a better approach might be to free up some/all of the equity in your property by either selling/re-mortgaging and invest the proceeds in AIM shares (see the article Take AIM & Cut Your IHT Bill.

WARNING: Whilst AIM shares provide the most complete shelter from IHT (after the 2 year period), they are unlikely to yield much income with which to pay debt or rent. Thus, the option is probably best suitable where you sell the family home, downscale and invest the surplus proceeds.

Sell at Market Value
Selling your house to your children or other relatives at full market value will result in the property being excluded from your estate for IHT purposes as no 'transfer of value' has taken place. After the sale you are free to spend the proceeds, perhaps for your retirement. Alternatively, you could invest the proceeds as mentioned above.

WARNING 1: There must be NO PRIOR ARRANGEMENT to give any part of the sale proceeds back to the purchaser - this will render the planning technique void (useless) as the sale would not have taken place at 'arm's length' and a transfer of value will be deemed to have taken place.

WARNING 2: There must be NO OBLIGATION on the purchaser to allow you to reside in the property. The purchaser can agree for you to occupy the property under an informal 'licence to occupy' which is totally at the purchaser's discretion.

WARNING 3: There is a danger as time passes that CGT considerations will outweigh any IHT savings. (see Capital Gains Tax & The Family Home for more details).
Stamp Duty Land Tax (SDLT) at rates of up to 4% will be payable on the purchase of property; this will also need to be borne in mind.

Full Consideration
Give the property to your children and then pay them a full commercial rent to reside there. This will bypass the GROB rules in addition to further reducing the value of your estate for IHT purposes.

WARNING: A drawback here is that your children would have to account for income tax on the rent you are paying them and they will also be fully exposed to CGT on the future growth of the value of the property.

Co-Ownership
Popular with widows, widowers and single parents with mature single children. Put the property into joint ownership with one or more of your children and live with them in the house.
The transfer of one or more shares in the house is a PET for as long as the child/children are living there - and it is the children's presence which prevents the gift constituting a GROB.

WARNING 1: If one or more of the children were to subsequently move out but the parent remain in the property, the only way of preventing the GROB rules from kicking in would be to pay the child/children rent at market value for their use of the child's portion of the said property.

WARNING 2: It is essential that each party bears their own share of the running costs; if any child were to pay the full or even part of the parent's share of the running costs after the transfer, then a GROB would have occurred completely undoing the IHT planning.

Shearing
This is a means of dividing up the legal interests in the property to reduce IHT in addition to avoiding the GROB rules. To use this planning technique, the transferor must have owned the property for at least 7 years, and if owned jointly by a couple, each must have owned their share for at least 7 years.
Furthermore, the method is only effective if there is no intention to sell the property - namely, that it is going to be retained within the family after the original owner's death.
Create a long term lease over the property which becomes effective some years in the future, i.e. 15-20 years' time. The lease is then granted to your children or other intended beneficiaries. The grant itself represents a PET which will be exempt from IHT provided you survive a further 7 years after having made the grant.
It is recommended that the length of the lease be 999 years; this is to ensure that the lease is long enough so that you do not benefit from the freehold reversion after the lease expires.
Furthermore, the commencement date of the lease needs to be timed carefully depending on the life expectancy of the donor/transferor, but cannot be more than 21 years after its execution.
By the time the lease comes into effect the value of the freehold interest in the property reduces, and if timed right, your interest in the house will have minimal value and easily be covered by the NRB and any TNRB available.
HMRC have confirmed that this planning technique does avoid the GROB rules but mainly in order that they can claim the income tax charge under the POA tax rules!!

PROBLEM - Live Too Long?
If you are stil living at the time the lease comes into effect, in order to avoid the GROB rules, you could begin to pay a commerical rent to your heirs named under the lease (although the POA tax as stated above would still apply). As an alternative, you might by this stage be prepared to downscale your property.

Three Way Split
This scheme could be useful on a property which is worth up to 3 times the amount of the NRB and exempt it from IHT.
To use this method, an assumption needs to be made about which spouse/partner will die first; if the assumption is wrong, the survivor wil need to reconsider their planning strategy (though should not receive an immediate IHT bill). (The scenario below will demonstrate a married couple of different sex but can equally apply to civil partners as well).

For argument's sake and based on statistics, lets assume the husband will die first. If the property is in England or Wales, it should be severed and put into tenants in common ownership with two thirds of the ownership going to the husband and one third to the wife.
Upon the husband's death, he leaves half his share (one third of the total) to a life interest trust in favour of his wife, the remainder going to the children. This will qualify as an immediate post death interest and consequently fall within the wife's estate, constituting an exempt spousal transfer on the husband's death, thus no IHT liability.
The husband leaves the other half of his share (one third of the total) to a discretionary trust, thus making use of the NRB allowance. At some future date (more than 2 years later) the trust can be wound up and the property share pass to the children.
NB: As an alternative, it might prove better, in order to protect the widow, to retain the trust and pay the most anniversary charges which the trust inevitably requires.
The wife allows an early termination of her life interest and passes that one third share of the property to the children. This will constitute a PET and will be exempt from IHT provided the wife survives another 7 years.
When the wife dies, her NRB can be used against her remaining one third share in the property.

WARNING: Some experts argue that the widow has an interest in possession in the discretionary trust's share and that the scheme would consequently fail. Again, the position on how successful this planning technique would be is unclear, and as mentioned above, it is certainly only worth considering this method if the property is worth more than twice the NRB.

The techniques described below will only be of benefit to married couples/civil partners where one or both spouses/partners still have a TNRB available.

Widow's Loan Scheme
This is where you can leave a specific legacy of a sum equal to the proportion of the NRB to a discretionary trust in your Will and the remainder or most of your estate to your spouse/partner who would be a beneficiary of the trust along with other family members. In essence, al or most of the deceased's assets are passed to the surviving spouse/partner who ends up owing a sum equal to the proportion of the NRB to the trust.
This scheme can be used for various assets but probably works better for the family home, as there is an asset on which to secure the loan, thus affording the necessary commercial substance. However, as noted above, it is now only worth looking into where one or both parties still have a TNRB.
The cost of implementing the scheme will vary depending on region and specialist advice should be sought regarding the various aspects involved.

Leave Share to Children
Where the property is held as tenants in common, and one or both of the couple still have their TNRB, an option would be to simply leave a share in the property to your children who will then become joint owners with the surviving spouse/partner. Bear in mind, the proportion of the share can be any you decide, it need not be equal.
If the property is sold by the surviving spouse/partner and children immediately after the first spouse's/partner's death, there should be no CGT. However, opinions vary on the situation where the spouse continues to reside in the property - namely, where it isn't sold immediately.

OPINION 1:
The surviving spouse/partner's share in the property will give them a continuing right of residence. Some experts believe this means that the survivor can remain in the house without paying rent and the children's share of the property is not included in the estate upon the survivor's death.

OPINION 2:
Contrary opinion however sates that the surviving spouse/partner's continued residence equates to an interest in possession. Thus, the children's share in the property would still comprise part of the survivor's estate unless they paid rent for their occupation.

OPINION 3:
Other's argue that a relevant property trust would exist in respect of the children's share. A relevant property trust arises where the beneficiary's' interest is not one of the following:

It is unclear which opinion is correct and HMRC have refused to comment. IF the method does work, there is still a drawback; the children are exposed to CGT on the growth of the value of their share after the first death. An important caveat here however, is that the CGT liability will often be less than the IHT liability, and if the family intend to retain the property for the long term, CGT is less of an issue in the long run.
In practice, this method has often proved unsuccessful with families literally coming to blows and even forcing the surviving spouse out of the property!

Children Put Share into Trust
Following on from the previous method, this option works as follows:

  1. Upon inheriting the share in the property the children set up a trust appointing the surviving spouse as trustee and beneficiary and then transfer their share into the trust.
  2. The provisions of the trust should be set up so that the property reverts to the children as settlors upon the death of the surviving spouse/partner.

WARNING 1: A problem with this option is that the trust will be a relevant property trust (see above) and thus subject to anniversary and exit charges.
On the plus side, these charges may be substantially lower than the amount saved by keeping part of the property out of the surviving spouse/partner's estate. In cases where the children's share is less than the NRB, this method in practice may save or avoid IHT on the house entirely.

WARNING 2:
The children will not be able to benefit from any CGT uplift upon the surviving spouse/partner's death. However, if the trust then sold its share of the property, the main residence exemption should be available as the property had been the main residence of the trust beneficiary. The sale proceeds could then be passed onto the children.

Leave Share to Discretionary Trust
There are problems with using discretionary will trusts. HMRC may well treat it as an immediate post death interest and thus will still be considered as comprising part of the surviving spouse/partner's estate. This is now only a problem for 'second time round' couples.
A possible solution is to leave an appropriate share in the family home to a discretionary trust but where the surviving spouse is NOT named as beneficiary.
As explained above, as joint owner the surviving spouse/partner will still have a right to reside in the home; not being a beneficiary of the discretionary trust makes no practical difference.
After a period of 2 years and a day, the discretionary trust can be changed into an interest in possession trust and consequently wil not fall into the surviving spouse/partner's estate.

WARNING: Anniversary and exit charges may well apply but as mentioned above, these may be avoided if the trust's share of the house is not worth more than the NRB.
This scheme is new and untested. Additionally the experts are still debating whether it will work in practice!!