The family home - Elderly Client Adviser

Feature

posted 24 Jan 2001 in Volume 6 Issue 2

FEATURES: THE FAMILY HOME

A three-part analysis by Emma Chamberlain Ralph Ray and Caroline Bielanska

Planning with the family home
By Emma Chamberlain

Introduction

The family home is often the most valuable asset in a person's estate and therefore invariably a subject of great concern for the elderly. This article considers the matrimonial home particularly in the context of it being jointly owned by an elderly married couple with children. Areas for discussion with the professional adviser usually centre on how to avoid the value of the home being subject to local authority claims in respect of residential care fees (a subject which is outside the scope of this article) how to preserve the capital of the home for the children but provide security for the surviving spouse and finally how to mitigate inheritance tax on the last spouse to die. It is the last two areas which are discussed here. This article also discusses some professional considerations to take into account when advising clients on the home summarises some of the options and examines the pitfalls.

The professional adviser may well advocate that complicated tax planning arrangements involving the main residence should be avoided. Even if security of tenure can be guaranteed this may be at the expense of flexibility later. Any planning must take into account the fact that people move sell up or could die in the wrong order!

Furthermore planning - whether inheritance tax or otherwise - must not be done without considering capital gains tax issues. The family home will generally qualify for the principal private residence (PPR) exemption on any disposal (section 222 TCGA 1992). On death any capital gain is generally wiped out (section 62). If instead the home is given away by the client during his or her lifetime then the PPR exemption may be lost and the capital gain accruing since the date of the gift will not be wiped out on the death of the donor.

Professional considerations

At the outset the solicitor or other professional advising on the home must consider his or her own position carefully:

Pressure from the children

The first question to ask is whether the client is in fact acting under pressure from the children. This can be a particular problem if say one spouse has died and the surviving spouse is the widow with children anxious to avoid paying inheritance tax on the mother's death. The adviser needs to beware of statements from the mother such as "I trust my children." The adviser might respond by asking if she trusts the children's spouses or pointing out the difficulties if the children die before her divorce or become bankrupt (Such advice should always be put in writing and the client should be seen alone). Not only does this better protect the adviser if questions are later asked but written warnings about the possible downsides of any course of action are often taken more seriously.

The adviser should always check the beneficial ownership of the home. Clients do not always remember how they own it! Is the home held as joint tenants or tenants in common? Is it in the sole name of one spouse?

Check if there is a mortgage on the home. Will it be paid off on the first death? If the house turns out to be owned as joint tenants this may nullify any inheritance tax planning although it may be possible to rectify the position by executing a deed of variation later after the first joint tenant's death retrospectively severing the joint tenancy. However this should not be relied upon. The second joint tenant may have lost mental capacity and be unable to sign such a deed.

Non-tax issues - protecting the home from second marriages

The adviser should bear in mind that there may be other issues apart from inheritance tax which need to be considered in relation to the family home. For example a client may have remarried late in life. He or she may want to ensure that the surviving spouse has the right to occupy the family home for his or her life but preserve the capital for the benefit of the children.

This problem is normally dealt with by leaving the deceased spouse's interest in the matrimonial home on life interest trust for the surviving spouse rather than giving the property to the surviving spouse absolutely.

If such a trust is used then a number of issues need to be considered. These are relevant in any plan involving the family home and a non-exhaustive list of questions to discuss with the client includes:

who pays for the various expenses such as buildings insurance and capital repairs? If the trustees then does the trust have sufficient cash?
what happens if there is a sale of the property? Should the trustees purchase a replacement home for the surviving spouse? And if there are any surplus sale proceeds should the surviving spouse receive the income from such proceeds or should they be distributed straight to the children?
who should act as trustees? Will the surviving spouse be a trustee?
should that spouse have the right to receive capital on any sale?
what happens if the surviving spouse remarries or starts living with someone?

These issues should be specifically addressed with the client and then sufficient powers should be inserted in the Will to ensure that the Trustees can achieve the objectives of the client. A letter of wishes may be appropriate.

Inheritance tax planning and reservation of benefit

Planning with the home usually focuses on reducing the inheritance tax liability when the last spouse dies. However any inheritance tax planning has to take account of the reservation of benefit provisions (see FA 1986 section 102- 102C as amended in FA 1999).

There will be a gift with reservation (GWR) if an individual disposes of property by way of gift on or after 18 March 1986 and either possession and enjoyment of the property is not bona fide assumed by the donee at or before the beginning of the relevant period; or at any time in the relevant period the property is not enjoyed to the entire exclusion or virtually to the entire exclusion of the donor and of any benefit to him by contract or otherwise. If a property ceases to be subject to a reservation before the donor's death that donor is deemed to have disposed of the property by making a PET at the date when the reservation ceases (FA 1986 s102).

The limb requiring exclusion of the donor necessitates exclusion not only in law but also in fact; therefore continuing to occupy the home without having any right to do so would still constitute a reservation of benefit. Further there is no apportionment test. If the de minimis rule is not satisfied so the donor is "virtually excluded" the whole of the gift remains subject to inheritance tax.

Market rent

There are a number of ways to avoid the GWR rules. One option is found in FA 1986 schedule 20 para 6(1)(a). In relation to gifts of land or chattels only actual occupation of the land or possession of the chattels by the donor is disregarded if it is for full consideration in money or monies' worth. So if a mother gives her house to son and pays the full market rent for her continued occupation such a gift will be a potentially exempt transfer. It is important that any tenancy is negotiated at arm's length terms with each party being independently advised (see Revenue letter dated 18 May 1987 to the Law Society in the Law Society's Gazette dated 1 June 1988).

Further full consideration has to be paid throughout the period of any tenancy and the rent should therefore be reviewed at stated intervals. The Revenue does accept that what constitutes "full" consideration must lie within a range of normal valuation tolerances (see Revenue interpretation in IR Tax Bulletin Issue 9 November 1993).

The gift of a house followed by the donor paying a full market rent is unlikely to be a serious option for most clients. High property yields compared with the relatively low yields on bank deposits and equities mean that the donor may well have insufficient income to pay such a rent. Further paying rent will generate an income tax for the donee.

Sell don't give

For GWR rules to apply there must be a gift on or after 18 March 1986 and further there must be a gift rather than a sale. (Gifts prior to this date are not caught by the provisions.) Therefore a mother selling the house now to her son and continuing to occupy it would not have done anything constituting a reservation of benefit. It would mean that the value of the cash is obviously part of mother's estate for inheritance tax purposes. On the other hand future increases in value of the property may fall outside the estate.

However this option is far from satisfactory - there is a loss of the principal private residence exemption for capital gains tax purposes and lack of security of tenure for the mother. The idea of a sale may be more relevant in relation to shearing or carve out exercises post Ingram and Another v IRC[1999] STC 37.

For example the freehold could be sold to a third party but subject to a lease for the benefit of the donor. The market value of a freehold interest subject to a lease is likely to be far less than the freehold interest with vacant possession and might be affordable for the children to pay. The argument is that there is no disposal by way of gift so section 102A cannot apply.

Relaxation where the donor has become infirm (See para 6(1)(b))

In the case of property which is an interest in land any occupation by the donor of the whole or any part of the land is disregarded if it results from a change in the circumstances of the donor since the time of the gift.

This change must be unforeseen at that time and not brought about by the donor in order to receive the benefit of this provision; it must occur at a time when the donor has become unable to maintain himself through old age infirmity or otherwise and it must represent a reasonable provision by the donee for the care and maintenance of the donor. The donee must be a relative of the donor or his spouse.

Gift of a share in land: joint occupation

Where the donor makes a gift of a share in land which is occupied by all the joint owners including the donor the Revenue does not treat this as a reservation of benefit. Prior to FA 1999 this was non-statutory but had been given Parliamentary authority by the 1986 Hansard statement of Mr Peter Brooke the Minister of State. This statement noted that: "elderly parents may make unconditional gifts of undivided shares in their house to their children and the parents and their children occupy the property as their family home...[with] each owner bearing his or her share of the running costs. In those circumstances the parents' occupation or enjoyment of the part of the house that they have given away is in return for similar enjoyment of the children of the other part of the property. Thus the donors' occupation is for full consideration. Accordingly... the gift with reservation rules will not be applied to an unconditional gift of an undivided share in land merely because the property is occupied by all the joint owners or tenants in common including the donor." [my underlining] See also the Revenue's letter dated 18 May 1987.

Section 102B(4) FA 1999 puts this relief on a statutory footing. There is no GWR where "the donor and the donee occupy the land; and the donor does not receive any benefit other than a negligible one which is provided by or at the expense of the donee for some reason connected with the gift." This does not appear to require the donee to occupy the property as his family home so weekend stays may be acceptable. The donor should either pay all the expenses of running the property or else not less than his percentage share in the land. The donee should not pay the donor's expenses.

If a client does not fall within any of the above exceptions the adviser will need to consider other options. These can usually be divided into testamentary and inter vivos planning. This article looks at only some of the possibilities.

Dealing with the home on death

There are far more possibilities available where the client is married because tax can be saved on the family home by careful Will drafting. It is assumed for the purposes of this article that the married couple own the house as tenants in common in equal shares the clients make no substantial lifetime gifts and that a half share in the house is worth about the same as an individual's current nil rate band (£234 000).

Leave share in house direct to children

The first spouse to die could leave his or her interest in the house direct to the children; if the surviving spouse also owns a share in the house he or she would have the right to occupy as a co-owner anyway. The main problem here is that the surviving spouse cannot be guaranteed sole rights of occupation.

There should in the case of children and surviving spouse co-owning be no problem in relation to the GWR rules although the other co-owners ie the children should not be debarred from occupation with the surviving spouse. No occupation rent will be payable by the surviving spouse if the other co-owners choose not to exercise their right to occupy but one would probably be payable if they wanted to occupy and a surviving spouse excluded them. The other owners would also have a right under Trusts of Land and Appointment of Trustees Act 1996 s14 to seek a court order for the sale of the property although this risk can in some circumstances be minimised. Even if matters can be structured so as to avoid a sale of the house without the surviving spouse's consent difficulties can arise if the surviving spouse later wants to move to another property and needs some of the children's share of the proceeds in order to purchase the replacement property.

There are also significant capital gains tax disadvantages in this route since the children's half share will not qualify for any PPR relief or uplift on the death of the surviving spouse.

A variant on this option is the "Reverter to Settlor" scheme. For example father dies leaving his half interest in the house to the children. Mother has a half interest as tenant in common. The children settle their interest received on their father's death upon trust giving their mother the right of occupation under the terms of the settlement. Any gain accruing to the trustees on the settlement of the sale of the house during the mother's lifetime will be exempt under s225.

If the mother dies before the house is sold then on her death there will be a tax free uplift to market value by virtue of s72 of the 1992 Act provided that the settlement is not terminated on the mother's death.

The capital gains tax exemption during her lifetime is obtained by giving the mother an interest in possession in the settled property and the termination of her interest on death or on earlier sale will not give rise to a charge for inheritance tax. This is because the exception from charge in s53(3) and s54(2) of the IHTA 1984 (reverter to settlor) will apply provided that the children become entitled to at least an interest in possession in the settled property when their mother's interest terminates. Certain points need to be watched under this route - in particular the children should not be under any obligation to resettle their interests.

Nil rate band discretionary trusts: leaving the home to the trust

The more traditional way of avoiding inheritance tax on the family home is by use of what is called the nil rate band discretionary trust. On the first spouse's death his or her share in the house passes into the nil rate band trust. The children and widow are the discretionary beneficiaries. The difficulty is that if a share in the home is left into a discretionary trust from which the surviving spouse can benefit the CTO has in some circumstances argued that such a trust is in reality an interest in possession settlement for that surviving spouse if he or she continues to live in the entire property. There are arguments against this point particularly if the surviving spouse owns a half share and thus has rights of occupation anyway. But it is something about which advisers will need to be aware and in any event putting a share of the house in such a trust has capital gains tax problems.

An alternative is to satisfy the nil rate band trust with a debt (The Will should include powers enabling the personal representatives to satisfy the nil rate band gift in the discretionary trust by means of a debt). It is the debt which forms the subject matter of the nil rate gift and the residence or share passes as a residuary gift to the spouse absolutely or for life. This route has been informally approved by Mr Tweedie of the CTO provided proper documentation is used. Generally the rule in drafting nil rate band discretionary trust Wills is to ensure that there are sufficient powers for the Trustees to take a debt.

Dealing with the home during lifetime

It is often not possible to avoid inheritance tax on the family home just by using tax efficient Wills. The client may not be married or the first spouse may already have died some time ago and the possibility of using his or her nil rate band has been lost. In this case the adviser will need to help the client in considering lifetime options.

One option which is being discussed widely at present is the "lifetime debt" scheme. Under this scheme the donor sells his home for full value to an interest in possession trust in which he retains a life interest. This preserves the principal private residence for capital gains tax purposes on any later disposal (section 225) and the base cost uplift will be available on his death.

The Trustees do not pay the purchase price over but give the donor an IOU for the property. The donor then gives the IOU away to the children or into trust for them. It is at that point that the donor makes the PET. There is some debate about whether the IOU should be repayable on demand or repayable only on the death of the donor. The former has inheritance tax risks the latter has capital gains tax disadvantages. The scheme has a number of other potential pitfalls including stamp duty on the sale the anti-avoidance provisions on debts contained in FA 1986 section 103 and problems raised by the FA 1999 changes. There are also some concerns about the artificiality of the scheme generally even if it works technically. Proper advice should be taken before any client considers such an option.

Summary

Planning which involves the home always needs careful thought. There are often no easy ways of achieving a client's objectives and much will depend on his or her individual circumstances. This article has looked at only some of the issues and possibilities but the adviser will need to consider all the factors carefully.

Emma Chamberlain Barrister at Patrick Soares' Chambers Additional tax aspects of the family and second home (all statutory references are to the Inheritance Tax Act 1984 - unless otherwise stated)
By Ralph Ray

Reversionary/deferred leases and the FA 1999 s104 anti-avoidance provisions:

The estate owner/client could retain the freehold and grant a long term e.g. 999 year lease for no consideration to arise after a specified number of years in the future preferably not exceeding 21 years. That number of years would be gauged to give that individual the required length of occupation as freeholder
Consider arranging for the lease to arise after a long fixed term or on the earlier death of the freeholder. This would mean that the freehold on the death must have only a nominal value and there should not be a deemed settlement under s43(3) as it merely refers to the creation of a lease and is not in any case "at a date ascertainable only by reference to a death"
The freehold interest and the reversionary lease should not merge on the owner's death (similarly in the lease carve-out it is better for the rump of the lease and the freehold reversion not to merge on the estate owner's death). This is to achieve a discounted value for the two interests i.e. avoid a "marriage value" and to avoid an attack under the "associate operations provisions in s.268
The Revenue may contend that a gift with reservation situation arises because possession and enjoyment is not bona fide assumed by the donee within the meaning of FA 1986 s.102. It is considered that such a contention would be incorrect because the donee has the full benefit of a saleable chargeable and assignable asset (see Commissioners of Stamp Duty v Perpetual Trustee Co [1943] AC425). As the lease will be for more than 50 years the income tax problem under TA 1988 s.35 will not apply. The owners of the reversionary lease will be able to enfranchise i.e. acquire the freehold without payment (Law of Property Act 1925 s.153); therefore the freehold of the deceased estate owner should have little value on the death. Enfranchisement depends on no rent being payable under the lease
The Revenue might also attack under s.163 (restriction on freedom to dispose)
FA 1999 s.104 - the greatest danger is that the reversionary lease scheme constitutes an arrangement and hence within the gift with reservation ("GWR") mischief but see the analysis to the contrary conclusion below.

Details of the FA 1999 s.104 legislation (amending FA 1986 s.102)

Subject to the exceptions below the new provisions apply to gifts made on or after 9th March 1999 where:

The asset given away is an interest in land e.g. a home (note that FA 1999 s.104 does not apply to chattels)
The donor or his/her spouse has a significant right or interest or is party to a significant arrangement relating to the land. (It would appear that this should not catch the reversionary/deferred lease scheme in many circumstances see below)
By reason of the right interest or arrangement the donor is entitled or able to occupy any of the land or enjoy some right in relation to it e.g. and typically a lease for a term of years.

The extended provisions will not apply where as with existing rules.

The gift is itself covered by the main exemptions from inheritance tax including transfers between spouses (e.g. where husband as sole freeholder gives wife a share so that they become co-owners as joint tenants or tenants in common)
The retained right or interest is negligible so that the donor is virtually entirely excluded from any enjoyment of the land - (as to what constitutes virtual exclusion see Revenue Tax Bulletin of November 1993 and Inland Revenue Manual 1/09/98 09:18:44 section D44)
The donor pays full consideration for his/her occupation of that land (see FA 1986 sch 20 para 6 e.g. a market value rent or premium) or
The occupation of the land is effectively forced on the donor by some unforeseen downturn in his/her financial circumstances (e.g. see the very restricted scope in FA 1986 Sch 20 para 6(1)(b))
The gift is made more than seven years after the right interest or arrangement concerned is created or entered into.

This latter exclusion seems to indicate that the GWR problem can be avoided if the estate owner uses a 14-year window.

Example

Lady Isabel carves out a lease for herself and her husband for 20 years on 10 March 1999. On the 11th March 2006 she gives away the freehold reversion to her children - i.e. as a PET. Lady Isabel dies on 12 March 2013. The gift of the freehold reversion appears to be effective as a PET and without GWR problems.

HM Treasury Explanatory Notes to Finance Bill 1999 state: For example a lease created and retained by a donor will not be a reservation in relation to the gift of the freehold reversion made more than seven years after the creation of the lease.

Contrast the normal GWR rules where time does not run at all towards the PET requirements in favour of the estate owner whilst he/she retains the benefit:

The gift is of a share in land which the donor then occupies jointly with the other owner (the donee) providing the donor receives no other benefit at the donee's expense in connection (see Emma Chamberlain's accompanying article under the heading "Gift of share in land: joint occupation")
Reversionary/deferred leases may well have survived this anti-avoidance legislation moreover in the following common circumstances: - if the donor/estate owner of the freehold has owned it for at least 7 years prior to the grant of the deferred lease. In construing new s.102A subsection ss5 states: "a right or interest [i.e. the freehold ownership] is not a significant arrangement for the purposes of subsection 2 [the new anti-avoidance charge] if it was granted or acquired [i.e. the freehold] before the 7 years ending with the date of the gift [i.e. gift of the reversionary/deferred lease which constitutes a PET]. (Note however the absence of the reference to significant interest this may give the Revenue some ammunition although one would contend somewhat futile)
Alternatively/additionally if the freehold was acquired by the estate owner for full consideration e.g. in the open market the full consideration exemption in new s.102A ss3 should apply
Assuming the donees of the reversionary lease are not in occupation there is clearly a CGT downside - unless the interest is still retained on death.

The Second Home IHT and CGT

Lifetime situations second homes: A particular use for discretionary trusts and CGT could be as to second homes utilising the holdover relief in TCGA s.260. Consider the following steps: -

Father [and mother] transfers a second home into a discretionary trust(s) showing a large gain in respect of which the son amongst others is a potential beneficiary. CGT holdover relief is available and hopefully no IHT payable because of one [or two] nil rate bands. If the home is owned by father and mother jointly - as tenants in common - separate discretionary trusts for each should be established
The trustees allow/entitle the son to occupy this home as his main residence but only after the discretionary trust vehicle has been established for some time e.g. 3 or 6 months; meanwhile entitlement to occupation would be deferred or a periodic or unenforceable licence exist. This is essential to indicate that a discretionary trust actually exists as contrasted with an interest in possession - see below
Subsequently on a sale by trustees the CGT main residence exemption should be available under TCGA s.225 and see Sansom v Peay [1976] STC 494. Alternatively if the trustees advance the house to the son and he sells CGT exemption should apply under TCGA s.222. Note that the substantial gain made by the father [and mother] can thereby be entirely washed out
During the 36 months preceding a disposal of the home the main residence exemption can still apply even though not occupied during that period (TCGA s.223(2)).
The sale of the son's home as above would constitute the termination of his interest in possession i.e. a deemed PET and insurance should be considered
Consider an alternative namely an interest in possession trust in favour of the spouse (IHT exempt) or a child (an IHT PET). A subsequent disposal by the trustees should be entirely CGT exempt. The CGT holdover relief into such an interest in possession trust would not however be available: contrast gifts into a discretionary trust
Consider also adapting this for other investment assets e.g. listed securities showing a substantial gain. The owner transfers these assets into a discretionary trust holding over the gain under TCGA s.260. The trust could have say 6 beneficiaries. After holding the assets for say a year the trustees operating within the IHT nil rate band distribute some of the trust fund to the beneficiaries holding over the gain again. When the six beneficiaries sell the assets they may each have their CGT annual allowance of £7 200. This could therefore save Â£17 280 of CGT.

Stamp Duty and the mortgage Trap - also a GWR for IHT

As is well known gifts have been exempt from stamp duty since 1985. The snag/trap referred to arises however where property (e.g. home or farming partnership) is gifted from A to B (including between spouses) subject to a mortgage or debt. Under the Stamp Act 1891 s.57 the debt (mortgage) assumed by the donee is consideration liable to 1per cent (minimum) ad valorem stamp duty above £60 000.

Possible Solutions:

Donee gives no covenant and assumes no liability i.e. donor remains solely liable. Note that: it is highly desirable to have an express written statement to that effect preferably in the deed of gift
The mortgage/loan is repaid and then a new mortgage/loan is taken out by the donee - but not contemporaneously or nearly so and preferably with separate borrowers. Ideally the donee would make independent arrangements prior to the gift
There could be several unconnected gifts (e.g. each not exceeding Â£60 000) where there is no obligation on the donor to make more than the initial gift. In these circumstances it should be possible to include the certificate of value on the basis that it is not "part of a series of transactions or of a larger transaction".

For further details see Inland Revenue Statement of Practice SP6/90 dated 27 April 1990.

Where a certificate of value that this consideration does not exceed £60 000 (FA 1958 s.34(4) as amended) can be given the problem is solved.

Stamp duty on all property (except as indicated below) is currently:

£0-60 000*	0 per cent
£60 001-250 000	1 per cent
£250 000-500 000	3 per cent
£500 001 and above	4 per cent

The rates apply to all assets e.g. debts homes commercial property (except shares 0.5 per cent and certain intellectual property - exempt).

The debt/mortgage liability assumed by the donee or indemnities given will also constitute a GWR for IHT in most cases. (See Emma Chamberlain's accompanying article).

Ralph Ray FTII TEP B.Sc(Econ)
Vice president STEP and Consultant Wilsons

Care fees aspects
By Caroline Bielanska

Many clients who have a boarder line Inheritance Taxable estate may wish to transfer the house during their lifetime because they are also concerned about residential care fees. For these clients it is imperative that you advise on the tax planning ramifications but also consider the implication on possible future liability for long term care. The Law Society issued their revised edition of guidelines for solicitors on the gifting of property in April last year and they are available from the Mental Health and Disability Committee. They have not been widely publicised but are now available on the Law Society website.

Those people who have a boarder line inheritance taxable estate and who make a lifetime transfer whether absolutely or in trust to another or others will require advice in case they fall foul of the notional capital rule. A local authority that is of the view that a resident has deprived himself of a capital asset in order to reduce his charge for accommodation may be treated by the authority as still possessing the asset. There may be more than one purpose for disposing of the asset only one of which is to avoid a charge for accommodation. Avoiding the charge need not be the individual's main motive but it must be a significant one. If the individual has disposed of an asset at a time when they are fit and healthy and did not foresee the need for residential care it would be unreasonable for the local authority to apply the notional capital rule. However as the incidence of care increases with age caution must be taken with the elderly client. If the inheritance tax savings are not significant it may be possible for the local authority to interpret the disposition as being made for the avoidance of care fees.

Certainly the best option for the married couple who wish to preserve assets is to dispose of assets by Will. Wherever there is a beneficiary who is disabled it is appropriate to consider a Will Trust. Such a Trust may have a benefit both for inheritance tax and care fees purposes.

Caroline Bielanska
Associate Solicitor with Longmores Hertford