Tax Planning and the Family Home: Common Pitfalls and Possible Solutions
Tax Planning and the Family Home: Common Pitfalls and Possible SolutionsBy Lee Sharpe | June 2012
There can be several reasons for wanting to gift the family home before one dies:
• Doing so can potentially reduce any inheritance tax (IHT) bill;
• It may mean that access to ‘state-funded care’ is easier, or cheaper;
• There may be fears that postponing the disposition could result in disagreement or discord amongst the family, particularly if health or capacity is at risk of diminishing. So making the decision in one’s lifetime is preferable.
Pitfall 1: Gifts With Reservation (of Benefit)
This is an IHT pitfall and is often referred to as “GWR” or “GROB” or similar. It is the ‘traditional’ problem which faces someone who wants to give the family home (or indeed other property) to (say) the next generation, but still needs somewhere to live!
Where property is given with pre-conditions, such as “You can have it but I want to be able to live in it rent-free until I die” then the IHT legislation states that the donor has ‘reserved a benefit’ in the asset.
For IHT purposes, where the GWR rules apply, then the asset in question is deemed never to have been given away: its value is treated as if it is still part of one’s estate on death – potentially subject to 40% IHT.
It is important to bear in mind that, as ‘anti-avoidance’ legislation, there is little by way of upside to the GWR rules: it is theoretically possible to get ‘caught’ for IHT both when making the original gift, and again on death – although there is provision to limit the double tax charge. This can be particularly difficult in the context of the family home, as the original gift can be effective in all other respects: the parent may be at risk of being thrown out of the property if he or she falls out with the donee; likewise the capital gains tax ‘main residence exemption’ may also be lost.
However, the GWR legislation was (and remains) quite particular about the nature of the property given/retained, and the identity of the parties involved. It was therefore potentially possible to get around the legislation – commonly by involving additional parties other than the donee. HMRC began to get frustrated about how quickly tax advisors were able to circumvent the GWR legislation and the IHT trap, so they devised “a cunning plan...”
Pitfall 2: Pre-Owned Assets Tax (“POAT”)
This is an income tax problem, and although closely related to the GWR above, if triggered it creates an annual income tax charge on the donor, rather than ‘waiting’ for an IHT charge on the estate. HMRC having learned their lesson with GWR, the rules are also very widely drawn and can be triggered in a broad range of situations.
Very simply, POAT is designed to catch anything that the GWR regime does not (in fact, one way of avoiding POAT is to make sure that the GWR rules are deliberately triggered). As the definitions for POAT are so wide, it is perhaps easier to explain by example.
Donald sells his large family home and gives his 3 sons the proceeds. He now has nowhere to live, so one of his sons – Huey – agrees to buy a larger house so that Donald can live with him rent-free. Donald is no longer in the original family home so cannot have ‘reserved a benefit’ in it: the GWR rules don’t apply. But he is now caught under the POAT, and will suffer an income tax charge by reference to the benefit he is deemed to enjoy, resulting from the proceeds of his old house.
The POAT can apply even in quite innocent circumstances: say for instance that Donald bought himself a new, smaller home and gave his 3 sons the difference so that they could each buy their first home. If he fell ill a couple of years later and moved in with Huey, the POAT charge could nevertheless apply. It is calculated by reference to the equivalent ‘market value rent’ on the property in question, and Donald would pay income tax on that amount, every year he stayed with Huey.
How to Avoid the Pitfalls
There are ways ‘around’ GWR and/or POAT.
For instance, it is possible actually to pay a full market rent.
If POAT applies and is just too expensive to meet from annual income but there is less concern about the IHT bill, then it is possible to elect for the POAT regime to be disapplied in favour of GWR instead – so income tax can be avoided now, but IHT will be due in the end. The election generally needs to be made by 31 January after the tax year in which the POAT would first be triggered.
There are other scenarios where both GWR and the POAT might be avoided, but they will not work for everyone.
Example – No New Property
Donald sells his house and gives the proceeds to his 3 sons – who already own their own homes. Rather than buy a new home, Huey extends his current home and Donald later moves in. Since Huey didn’t go out and buy a new property, Donald may avoid both the GWR and the POAT regimes.
Example – Wealthy Children
Donald sells the freehold in the family home after he has secured a lease in the property for (say) 20 years. The value of the property subject to a 20 year lease is very much reduced. He then sells the freehold in the property for full market value, to Huey.
Remember that the property is worth substantially less than it would be as an ‘empty’ property. Donald hasn’t ‘given’ the property to Huey (so there’s no GWR) but Huey will eventually end up with a property with no tenant – and empty, it will be worth much more than he paid for it. Note that this planning assumes that the length of the lease will be sufficient to provide Donald with a home for the rest of his life. Donald must also be sure that he hasn’t ‘helped’ Huey financially to buy the property, otherwise the POAT could be triggered.
Practical Tip :
The key point to bear in mind with the GWR and POAT is simply to be aware of them and how they can apply. Given how broad the rules are – particularly with the POAT – it is strongly recommended that if you think they could be relevant, then speak to a professional adviser for specific guidance.
This article was first printed in Property Tax Insider in April 2012.
I wholeheartedly recommend the ‘Tax Insider’ to anyone who is interested in legitimately minimising their tax bill.
Dr Bennie Mallett, General Practitioner