Protecting the family home

In his March Budget, the Chancellor made great play of increases in the inheritance tax (IHT) threshold above the normal inflation linked rises. The limit is now £275,000, up from £263,000 last year and will rise to £285,000 in 2006 and £300,000 in 2007. This is small comfort to the many families who find themselves within the IHT net, primarily because of the value of their homes. If the IHT threshold had been increased in line with house values since 1997 it would now stand at over £500,000.

As a consequence much IHT planning in recent years has focused on ways of removing the family home from the estate for IHT purposes whilst continuing to live there. In simple terms an outright gift of the home to, say, your children whilst you continue to live in the house is ineffective for IHT purposes. The property will still be treated as part of your IHT estate by virtue of the ‘gift with reservation’ rules.

Complex schemes were therefore developed to allow continued occupation of the property whilst removing it from the IHT estate. A variety of schemes were used, the most common being the ‘home loan’ or ‘double trust’ scheme. The government has now acted to outlaw such schemes and, since 6 April 2005, the pre-owned assets tax charge has been in place. This imposes an income tax charge based on a notional market rent for the property. Assuming a rental yield of 5%, the annual income tax charge for a higher rate taxpayer on a £1 million property would be £20,000. However the upside is that the property is not treated as part of the IHT estate and so the IHT saving (after taking into account the £275,000 nil rate band) would be £290,000.

The new charge has been criticised on several counts. It involves valuation of the property to establish the income tax charge - at best a costly and subjective matter. It is also seen by some as retrospective in that it can apply to arrangements put in place at any time since March 1986.

Two critical questions arise.

Is there any planning that still works?

There is no easy answer. Space does not permit us to set out the available options in full in this newsletter but the following could still be considered:

• Discretionary will trust
• Deed of Variation
• Equity release schemes
• Sharing arrangements - whereby the parent and (adult) child share the property.

The new charge will only apply to those who have entered into certain schemes or arrangements. But what can be done to avoid the new charge?

The options are limited but the following could be considered:

1. Dismantle the scheme, although this may be complex and costly and in some cases impossible.
2. Elect to treat the property as part of the IHT estate. This will achieve the same tax result as 1 - ie no income tax charge but loss of all IHT ‘savings’.
3. Move house or pay a full market rent for use of the property.

Inevitably given the complex nature of these schemes avoiding the new charge is not easy.

IHT planning is a very personal matter and the most appropriate solution will differ from family to family. We would welcome the opportunity to talk to you about IHT planning. Please give us a call.