Helping children onto the property ladder

We shall be looking at improving children’s access to capital from the perspective of parents or grandparents who have a property portfolio and therefore capital wealth, but are ‘locked’ into bricks and mortar.

 

Property taxation is fraught with potential traps. For example:

• Restricted income tax relief on borrowings to finance residential lettings;
• Stamp duty land tax (SDLT) (or local equivalents) can be onerous for higher-value properties – especially with the additional 3% ‘surcharge’ that applies to buy-to-let properties;
• Capital gains tax (CGT) has an effective 8% surtax on the disposal of dwellings; 
• Inheritance tax (IHT) awaits, and most property investment businesses cannot access the business property relief that is available to most trading businesses so that the latter doesn’t have to be ‘broken up’ to pay off IHT;
• Property is ‘lumpy’; one tends to hold only a few but they each have high value, and it is cumbersome to keep moving the ownership of fractions of property. A gift of property to someone other than your spouse/civil partner will normally be subject to CGT as if you had sold it for its full market value. 

In particular, there is anti-avoidance legislation to consider, such as:

• ‘Settlements’ legislation;
• Gifts with reservation of benefit;
• Pre-owned assets tax

Broadly speaking, these act to ensure that you cannot give something away while continuing to derive any benefit from it. 

 

Children under the age of 18 cannot hold legal title to property but they can hold a beneficial interest in property beforehand. One can gift property (or an interest therein) to a simple trust that holds the property until they are old enough to give good receipt; meanwhile, any rental income, etc. belongs to and can be taxable on them. 

 

Gifts directly from parents to minor children can be caught by the settlements legislation to ‘bounce’ any resulting investment income back to the donor parent, but grandparents, etc., are not generally caught.

 

More complex trust arrangements can be devised to ‘hold on’ to the property for longer if there is concern that children/grandchildren will not be mature enough to handle significant wealth at age 18.

 

Wealth planning prefers a timeframe of decades, rather than months. A married couple or civil partnership can trigger a gain of £24,000 this tax year (2019/20) but pay no CGT, as the personal annual exemption is £12,000. Given time, even relatively modest transfers can accumulate to significant capital wealth without having to pay any CGT. 

 

It is also possible to make regular gifts out of one’s surplus income that are immediately exempt from IHT, and do not interfere with the usual £3,000 per annum limit (nor do they have to be survived by seven years). Depending on the extent of one’s surplus income, such gifts can dwarf the traditional gift limits. Gifts out of surplus income can effectively act as a ‘safety valve’ to stop further funds accumulating unnecessarily in one’s IHT estate; that is what the regime is designed for.

 

Gradual transfers of wealth can more easily be effected by giving away shares in one’s property company over time, instead of fractional interests in the properties themselves. Note that a poorly-drafted arrangement to transfer property interests over several years can easily result in CGT arising on all the planned transfers, immediately.

 

Note that the 3% SDLT surcharge will apply to the entire purchase price when any co-owner is not buying their only property/replacement home, etc., so co-investing in the property directly, alongside a first-time buyer, can be tax-inefficient. Likewise, if the young buyer hopes to benefit from the main residence CGT exemption, any interest in the property that is attributable to a joint investor who has not occupied the property as their only/main residence will not benefit. 

 

It may therefore be more tax-efficient to lend money to the young buyer, so that their more tax-efficient acquisition and ownership covers more/all of the property.

 

The older lender acting as guarantor can sometimes increase access to lending arrangements or reduce their cost – but there is a risk that such a guarantee may be called in. If you have spare capital wealth but want to retain it ‘just in case’, consider using it as funding for an offset arrangement that will again act to reduce the borrower’s finance costs; it may also prove slightly more tax-efficient for you as you will no longer be taxed on the 0.00005% interest that you might otherwise have earned! Here again, though, the offset funds are at risk if the mortgage defaults.

 

Of course, lending money, acting as guarantor or providing funds for offset mortgages has no effect for IHT or CGT purposes, although one’s estate would practically be affected if the worst happened and the funds were forfeit.

 

Parents, etc., are sometimes required (or advised) to put their names on the legal title to mortgaged property; but without any actual beneficial interest such as a joint owner would ordinarily have (simply, their names might be recorded on the land register but they have no entitlement to proceeds from sale, etc.). The SDLT surcharge guidance has been updated specifically to confirm that a purely legal interest will not trigger the additional 3% (see HMRC’s Stamp Duty Land Tax manual at SDLTM09764, or paragraph 3.13A of the updated guidance).

 

The government’s help-to-buy individual savings account (ISA) is potentially useful: the government will ‘top up’ a qualifying investor’s fund by 25% - to a maximum of £3,000 on savings of £12,000 (overall – not annually). A qualifying investor has to be 16 or over and saving to buy their first home (to live in, although they can rent it out later on). The target property cannot be worth more than £250,000 (£450,000 in London). 

 

Help-to-buy ISAs are available to new entrants only until 30 November 2019 (although those who have already set one up can continue to invest afterwards), so readers may want to move promptly or not at all. 

 

There may come a time when parents want to divest themselves of capital but retain their income, to cover current or anticipated living costs, care fees, etc.

 

It would be possible to give most of the ownership in a rental property to adult children or grandchildren, but then to agree to share the net rental income therefrom so as to favour the older co-owner(s). HMRC’s Property Income manual states (at PIM1030) that in the absence of a formal partnership business:

 

‘…the share of any profit or loss arising from jointly owned property will normally be the same as the share owned in the property being let. But joint owners can agree a different division of profits and losses and so occasionally the share of the profits or losses will be different from the share in the property. The share for tax purposes must be the same as the share actually agreed.’

 

Strictly, the younger owner is entitled to demand his or her ‘fair share’ of the net rental income, so it could be argued that he or she is ‘giving’ away their income, and this might be considered a ‘settlement’. However, the settlements legislation is meant to apply only where a person ostensibly gives away his or her income but somehow still benefits from it; if the younger co-owner ‘genuinely’ does not benefit from the share he or she gave up, there may be a settlement, but that alone does not trigger the anti-avoidance tax legislation.

 

There are many routes to helping children, etc. onto the property ladder. Some are more tax-efficient than others, but sometimes tax efficiency takes a back seat to family commitments. Long-term planning is highly recommended in order to balance the different requirements of the various tax regimes that may apply, and it is vital that readers seek the appropriate financial, legal and/or tax advice before implementing any relevant planning measures.