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Band of bothers

Planning Strategy – Increases in the nil-rate band have failed to keep up with house price inflation so how can homeowners plan for IHT caused mainly by their residence? By Scottish Widows senior technical manager for savings and investment Anne Young.

Looking at house price rises over the last 10 years, it is hardly surprising that many more people now have an inheritance tax problem. In this period, the nil-rate band has increased by just 39 per cent from £215,000 to £300,000.

Many people’s property alone is worth more than the nil-rate band and most have other assets to take into account. What can be done to alleviate an IHT problem caused largely by the main residence?

When dealing with couples, consider recommending that the basis of ownership of the main residence be changed into tenants in common. The asset can then be used as part of any legacy into a discretionary will trust on the first death.

Be careful with IOU trusts, given the decision in the Phizackerley case. If the IOU route is chosen, it may be necessary for the executors to show that both parties contributed to the assets that went into the discretionary will trust and were subsequently loaned to the survivor.

It may be safer to put just the share of the house into the trust. The main potential problem with this route in the past was that HM Revenue & Customs could claim that the survivor had an interest in possession. It could be argued that this view has less chance of success post-March 22, 2006, where an interest in possession can only be claimed if it is an immediate post-death interest.

Beware of transferring ownership of the house to children while the original owners are still alive. If they continue to live there, this would be a reservation of benefit and, therefore, an ineffective gift if a market rent is not paid.

This market rent would be assessable to income tax on the owners, who could also be assessable to capital gains tax when the property is eventually sold.

Where a proportion of the property is transferred to someone else who then shares occupation with the original owner, this can work as a potentiallyexempt transfer although each must pay the appropriate share of the property expenses and upkeep.

Another issue to consider is the ownership of a second property. A lifetime gift of a second property could be considered but remember that such a gift is a disposal for capital gains tax purposes and could trigger a charge. An alternative to an absolute gift would be to make it to a non-bare trust. In this way, the gain could be held over and at least delayed. A rent should probably be paid for any future use of the property. Apart from anything else, the trustees would be failing in their duty to look after the beneficiary’s interests if they did not charge a rent.

When dealing with the primary residence, equity release is always an option. You can realise capital from your property which may enable you to have a more comfortable life or do some lifetime IHT planning such as gifts or perhaps a discounted gift or loan trust.

IHT is mainly a problem on the second death of a couple although there are serious issues on first death for unmarried couples who may mistakenly believe that they are treated in the same way for IHT as married people or civil partners.

Much of the potential problem on second death may be caused by what happens on first death. On first death, life insurance or pension policies may pay out a lump sum. In many cases, the lump sum in a single-life policy is paid to the survivor as the beneficiary in a will or the nominee in a pension policy. The recipient may welcome the money but the result is an increased problem on second death.

How much better if these sums are held for beneficiaries, including the survivor, in a trust? The funds are available to the survivor at the discretion of trustees but are not in the estate for IHT purposes.

If the survivor needs funds, although the trustees can appoint capital under the terms of the trust, it might be better to consider loans. That way, the survivor’s estate has a debt on it.

Debts are very good IHT planning. It is important that any loan is substantiated by a properly documented loan agreement and that a copy is kept with the lendee’s will so that the executors know about the loan and can make a valid claim for a deduction for IHT. It is also essential (remembering Phizackerley) that the survivor/lendee is never deemed to have contributed to the trust. All single applicant policies should therefore be paid from a single bank account in the applicant’s name.

Planning with property is fraught but there are still many ways to reduce IHT or, at the very least, not make the matter worse.

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