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Home brew

Despite a brief interruption by my ramblings on the pre-Budget report, I have recently been concentrating on the important subject of inheritance tax planning using the principal private residence. On the face of it, this may seem like a subject of only passing importance to financial advisers as it does not involve any financial product but this would be a short-sighted view.

If the core offering of your business is the provision of advice rather than the execution of transactions, you need to be equipped with at least a basic understanding of what is and isn’t possible in connection with planning with this most important of assets for many clients.

Given the increased difficulty in effective IHT planning with the private residence, it is highly likely that alternative planning strategies will involve financial products. Before looking at some strategies in detail, it is important to understand the fundamentals.

In my last article I looked at the two main ways in which property can be jointly owned in the UK – as joint tenants and as tenants in common.

It is reasonably well known that jointly-owned property needs to be owned on a tenancy in common basis if one party is to make a gift of their share during lifetime or on death. It is worth knowing, though, that a joint tenancy can always be converted into a tenancy in common by a notice in writing to the other joint tenant(s) or by all joint tenants executing a deed of severance.

Whichever of the two forms of beneficial co-ownership is used, the legal ownership must operate through a trust of land (Law of Property Act 1925, sections 34-36). This means that the property is held by all parties for their benefit. Under the Trusts of Land and Appointment of Trustees Act 1996, no party can sell the property without consent of the co-owners.

Where co-owners cannot agree on a sale, an application can be made to the court for an order of sale under section 14 TLATA 1996. This creates uncertainty as well as expense. In considering whether to order a sale, the court, which has complete discretion in the matter, will take into account the intentions of the person who created the trust, the purpose for which the property subject to the trust is held and the welfare of any minor who occupies or might reasonably be expected to occupy any land subject to the trust as his home (TLATA 1996, sections 14 and 15).

Trustees have a statutory duty to consult the beneficiaries and give effect to their wishes in so far as these are consistent with the general interests of the trust – usually only of importance where the legal interests are held by different persons or in different proportions to the beneficial interests.

In making a lifetime gift of a private residence or a share in it, important tax issues must be taken into account. First, it is necessary to avoid the gift with reservation of benefit provisions in section 102 Finance Act 1986. The donor should not enjoy any benefit from the gift or the property value will continue to form part of his taxable estate on his death. Three main exceptions exist to this rule:Where the donor pays a full market price for his enjoyment (a rent in the context of the family home).Where the donor’s enjoyment of the home arises out of a change of circumstances since the gift. For example, if having made the gift, some years later the donor becomes infirm or disabled and then occupies the house, the occupation will not be regarded as a reservation of benefit.Where the donor’s continued benefit is minimal.

Let us look at these in more detail. I will cover the commercial rent exception next week. The key conditions to be satisfied for the exception concerning reoccupation following ill health are that the reoccupation:Results from a change in the donor’s circumstances since the time of the gift, provided it was unforeseen at that time and was not brought about to enable him to benefit from the rule.Occurs when the donor has become unable to maintain himself through old age, infirmity or otherwise.Represents reasonable provision by the donee for the donor’s care and maintenance.The donee is a relative of the donor or his spouse.

The qualifying conditions for the minimum benefit exception were well explained in the Inland Revenue’s Tax Bulletin of November 1993 which provided useful guidance on how this exception would be interpreted. Some examples of what is acceptable are as follows:The donor stays in the house without the donee for no more than two weeks a year or with the donee for less than one month a year.The degree of social visits by the donor (excluding overnight stays) are such as might be expected in the absence of the gift.It is a temporary stay for some short-term purpose, say, convalescence by the donor after medical treatment, the donor looking after the donee during the donee’s convalescence or during redecoration of the donor’s own home.The visits are for domestic reasons, say, babysitting of the donee’s children by the donor.

The Revenue did warn that where the benefit to the donor becomes more significant, the gift with reservation provisions might apply, say, where the donor spends most weekends in the house or where the gift involves a holiday home which both donor and donee use.

There are a number of other ways whereby an individual might escape the reservation of benefit provisions and make effective transfers for IHT purposes. Ceasing to reside altogether in the property after the gift is the most obvious way. The prior sale of the property followed by an unconditional gift of the cash proceeds may also be attractive. If after a period of time the cash is used to buy a property for the occupation of the original donor, it would seem there would be no gift with reservation because it is not possible to trace a gift with reservation through cash. Great care must be exercised and all actions must be unconditional. This course of action could also cause problems with the pre-owned assets tax.

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