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Using trusts to gift property

According to the latest estimates, HMRC's inheritance tax receipts are to be about £4,637m for 2015-16, which is an increase of 22% from 2014-15. Since 2009-10 IHT receipts have increased year on year on average by 12% each year. Some of it is due to the nil rate band being frozen at £325,000 since April 2009 but the main reason is rising asset values. Unsurprisingly perhaps at Technical Connection we receive an increasing number of questions about planning for effective reduction of estates through gifts. This goes hand in hand with the desire of many parents to help their children on the property ladder.

General problems with planning with owner-occupied property and the impediments to such planning, including the gift with reservation provisions (GWR), pre-owned assets income tax (POAT) and anti-avoidance legislation, are well-known, but a reminder is included in the section below. More often these days the question is about gifting a holiday home or a buy-to-let property, alternatively, about gifts to fund the purchase of a property for a child. For various reasons an outright gift is often inappropriate which is where trusts come in. So this month we will look at some of the tax implications of gifting a second property, or cash to buy such a property, via a trust.

Background to gifts of property

First, some key tax issues to remember if an effective lifetime gif of property is planned:

1. It is necessary to avoid the GWR provisions in section 102 Finance Act 1986. In particular, the donor should not enjoy any benefit from the gift or the value of the property will continue to form part of their taxable estate on  their death. In general, there are three exceptions to this rule:

  • Where the donor pays a full market rent for their use/enjoyment
  • Where there is relatively little benefit to the settlor following the gift (e.g. short visits for domestic reasons)
  • Joint /shared ownership and occupation - only relevant if the donor and donee can in fact share the occupation of the property.

A prior sale of existing property followed by an unconditional gift of the cash proceeds may also be an alternative.  If the cash, after a period of time, is used to buy a property for the occupation of the original donor it would seem that there would be no gift with reservation because it is not possible to trace a gift with reservation through cash.  In following such a course of action, great care would need to be exercised and all actions must be unconditional.  Such a course would, however, be caught by the POAT charge unless the cash of gift was made more than seven years before the first POAT charge applies.  

2. Capital gains tax needs to be considered. If the property is not the principal private residence of the donor, the gift will constitute a disposal for  capital gains tax (CGT) purposes and there are restrictions on how hold-over relief can be used when property is transferred to a discretionary trust in certain situations - see below for a full explanation.

3. Whilst stamp duty land tax (SDLT) is not charged on gifts, it may apply if the arrangement involves an element of sale or other valuable consideration. It will also be relevant if a second property is being purchased (say with gifted cash), especially if a trust is involved (see later for more details).

4. The POAT provisions - largely applying when the GWR provisions are avoided - must be seriously considered as they are of extremely wide potential application. 

Planning with second property - general

It is generally easier to make lifetime gifts of this type of property without infringing the GWR provisions even if the donor intends to use the property occasionally. However, it is also necessary to take into account the POAT provisions as 'occupation' is construed widely for these purposes.  Avoiding these provisions can be achieved using the co-ownership route or by the donor paying rent for the time spent in the gifted property.  Both are based on the commerciality underlying the arrangement.  These options may be particularly suitable for a holiday home which the donor would either want to use only occasionally or in proportion to the share of the property they retain (the latter when the property is  transferred into joint ownership).

Alternatively, unconditional cash gifts that are invested by donees in second properties that the donors occasionally use can avoid the GWR problem because it is not possible to trace a gift with reservation through cash.  However, this route would not be effective to avoid the POAT provisions whichdocontain tracing provisions.  For this purpose it makes no difference whether the gift is made to an individual or to a trust. However, the higher rate of SDLT needs to be taken into account for the purchase of second properties (see below).

The choice of trust

If an outright gift is not appropriate, perhaps because of the age of the intended donee or because of concerns about protecting the asset, for example from potential divorce claims, a trust will normally be considered. One of the often used strategies in the past involved setting up a discretionary trust, not only because of the flexibility it offers but also because it offered  CGT advantage in certain circumstances - this planning was stopped some years ago as explained below. The choice will normally be between a flexible power of appointment interest in possession trust (i.e. with a named beneficiary entitled to the interest in possession) or a fully discretionary trust. A bare trust would only be used if there was no need to retain any flexibility or the donee was a minor or otherwise incapable.

Since the introduction of the additional SDLT charge on a second property, it now appears that the choice of trust, when cash is to be gifted with a view to purchasing a property for the beneficiary's use, may well be driven by the SDLT provisions. The interaction between the SDLT and trusts is explained below.

Gifting a second property to a discretionary trust - restriction on the use of hold-over relief.

When a gift for IHT purposes is a chargeable lifetime transfer, such as a gift to a discretionary trust, and it also amounts to a disposal for CGT purposes ( such as a gift of a property), then CGT hold-over relief can normally be claimed under section 260 TCGA 1992. Prior to 10 December 2003 it was possible to avoid a CGT charge on a gift of a second property by making a prior gift of that property into a discretionary settlement.  Any capital gains could be held over on transfer into the trust.  The next step was for the beneficiary and trustees to elect for the property to be treated as the beneficiary's principal residence for CGT purposes.  On a subsequent sale the principal private residence exemption applied to the whole gain (i.e. including the held-over gain). 

However, private residence relief is not available for disposals made on or after 10th December 2003 by an individual or the trustees of a settlement, where the computation of the amount of any gain arising on the later disposal by the trustees has to take account of hold-over gifts relief obtained under section 260 of the TCGA 1992 in respect of an earlier disposal.

These provisions do not apply in any case where the gain arising on the disposal is not in any way affected by a gifts relief claim under section 260 of the TCGA 1992 in respect of an earlier disposal into the trust.

SDLT and trusts

On 1 April 2016 a SDLT surcharge was introduced for certain purchases of dwellings, such as second homes and investment properties. This works by increasing the current SDLT bands by three percentage points: so the 0% band becomes 3%, 2% becomes 5%, 5% becomes 8% and so on. For example, if the rules apply the SDLT liability for the purchase of a dwelling for £500,000 will increase from £15,000 to £30,000. What if the purchase is through a trust?

Here it is important to identify the type of trust in question, as different considerations apply.

Bare trusts

This arises where the beneficiaries are absolutely entitled to the trust property, including where the beneficiary simply can't own the legal title for some reason (such as age or disability). A "nominee purchaser" arrangement is also a bare trust. In these cases, HMRC simply looks through the trust and treats the beneficiary as owning the property. So the surcharge will apply or not by reference to the position of the beneficiary.

Life interest or flexi interest in possession trusts

For the purposes of the 3% charge, this is where the beneficiary is entitled either to occupy the property for life, or to receive trust income from the property. Broadly speaking, a beneficiary of this kind is treated as owning the property personally so, if they purchase a property personally, the additional rates could apply to that transaction. Because the beneficiary would be caught by these rates, any purchases by the trust are also potentially subject to the surcharge.

In both these cases it does not matter that legal title to the trust's residential property will not be registered in the beneficiary's name, and it is also generally irrelevant whether the trustees personally own residential property interests.

Discretionary trusts

Under a discretionary trust the trustees have discretion to apply capital and income for different beneficiaries at different times. Here HMRC ignores the beneficiaries and simply treats the trust as a non-individual purchaser. This means the additional rate willalwaysapply if the trustees purchase a major interest in a residential property with a market value of £40,000 or more, and which is not subject to a lease of 21+ years, regardless of whether any other residential property interests are involved.

This extra rate for discretionary trusts may well be a deterrent when considering the type of trust through which to hold property although, as always, the tax considerations will only be one of the relevant factors to take into account. However, if the intended beneficiary does not already own a property and does not intend to buy one, then an  interest in possession trust holding the residence would clearly be a more tax efficient option, given that the 3% charge would  not apply, as explained above. .

Conclusion

As can be seen from the above, making gifts of property or gifts of cash with a view to purchasing a property is far from straightforward. However, as more people get caught in the IHT net and express a desire to take steps to mitigate it, financial advisers must be aware of all the relevant considerations if they are to offer good advice.