On the one hand, it increases family wealth as, generally speaking, over time its value increases (possibly substantially) but on the other hand this increase may well push a family’s total estate into a charge to inheritance tax (IHT) on death, currently levied at the “death” rate of 40%. IHT applies on death on that part of an estate over £325,000 (referred to as the nil rate band (NRB)).
For married couples, any such IHT charge may be deferred. For example, if on the death of one spouse the surviving spouse inherits all of the deceased spouse’s estate no IHT arises as gifts between spouses are normally exempt. On the death of the surviving spouse an IHT charge may arise but it has at least been deferred; furthermore the surviving spouse in this case is entitled to two NRBs ie £650,000. IHT will thus arise only if the surviving spouse’s estate exceeds £650,000 if both NRBs are available.
Gifts with reservation
One option to mitigate (ie avoid) any such charge is for parents to gift some percentage of their respective interests in the home to one or more of their children. Such gifts are potentially exempt transfers and if the donor parent survives at least 7 years no IHT arises either on the gift or on the parent’s death; unfortunately if, the following the gifts, the parents continue to reside in the home (as would typically happen) the gifts fall to be treated as “gifts with reservation” and on their deaths the value of the home is re-included as part of their estate and IHT is levied thereon; thus no IHT is avoided. The solution is co-ownership.
Co-ownership
Co-ownership involves both parent(s) and child(ren) owning a percentage of the home. This would involve either or both parents gifting some part of their interests in the home to one or more children who must then live in the home with the parents.
This may not suit all families but may perhaps be viable where, for example, one parent is elderly and perhaps infirm and one or more children move back in with the parents to help look after them; or, due to the difficulty of children being able to afford to buy their own home they might continue to simply live at home.
To achieve the IHT saving one or both parents would gift a percentage of the home to (for example) one child who would then live with the parents in the home. In practice, the percentage that might be gifted may be up to circa 75% (HMRC appear to “dislike” gifts of a greater percentage for some reason); thus, in this example each parent would gift 37.5% to the child who would then own 75%, each parent retaining a 12.5% interest.
It is important to avoid the gifts constituting gifts with reservation (see above). In practice this requires that the parents must, following the gifts, continue to bear at least their share of the home running expenses. Assuming two parents and one child occupy the home then the parents should bear at least 2/3rds of the total running costs (eg water; gas; electric etc); if appropriate the parents can bear more than the 2/3rds (eg 100%). Under no circumstances, however, should they bear less. It may make sense to set up a joint bank account between parents and child with each contributing (each month or from time to time) to it in the relevant percentages.
With respect to major capital (ie “one-off”) works (eg roof repairs; new kitchen) the contributions should be in line with the underlying ownership percentages (ie in the above example, child contributes 75% and each parent 12.5%); again the parents contributing at the very least their 12.5%.It is important, however, that the child does not move out of the property prior to the deaths of the parents, otherwise the parental gifts become re-classified as gifts with reservation and IHT is then chargeable on the surviving spouse’s death on 100% of the property (not just on the 25% actually owned); the arrangement should therefore be viewed as a long term arrangement.
Co-ownership also means that on any sale of the property no capital gains tax liabilities would arise either on the parents or child.
Practical Tip
If the aggregate estate of the parents is below £650,000 (and assuming that both individuals’ NRBs are available) no IHT will be due on death and adopting the co-ownership concept will not be needed, at least, for IHT purposes.
Michael Finney
