Success of property via a trust

Hi all,

I just wanted to run something past everyone. Client jointly owns a property with his wife and wants to pass it on to his 2 adult kids. MV is £950k (no debt). Base cost is £550k. It’s his second home. Would any of the following work:

  1. Set up a discretionary trust, and the trust buys the property for consideration of £300k, and the remainder £650k is transferred as a lifetime transfer. The £300k consideration receivable is gifted to the kids as a PET. The property is kept in the trust going forward (10 year charge etc)

  2. Same as above, but the property is transferred out to the kids after 6 months and CGT is avoided by claiming holdover relief

Is this a question about tax? If it is you may wish to say something about Mum and Dad’s future use of the second home, their life expectancy and their aggregate net worth for starters.

And have the kids bought their first home yet?.

Hi Duncan

Yes it’s about tax. Some additional details below:

Mum and Dad are 57 and 59 in age, respectively.

They do not intend to reside in the second home going forward.

Aggregate net worth is £1.9m.

The kids (25 and 30) have not bought their first home yet.

Regards
Abdul

Dear Abdul

1 The £300k price will reduce the IHT transfer of value from £950k to £650k, and perhaps less by as much as £12k if annual exemptions are available. The parents will lose their NRB for 7 years but that may be less of a concern if they are young/in good health and gift insurance may be cost-effective. The parents must be excluded from benefit under the trust or it will be a GROB. It is better to have two identical trusts one by each parent to avoid a joint trust.

A potential advantage is that any future appreciation in value will not be in the parent’s estate but in the trust. At the first 10 year anniversary, ignoring appreciation, the IHT charge will be nil provided the £300k debt does not have to be discounted (see 4 ). It is possible with the same proviso that the the property can be distributed before that event at a nil rate.

2 For SDLT, whether there are two trusts or one, a full distribution will be a sale at £300k so 5% of £50,000 = £2500. Two trusts will be a linked transaction.

3 CGT is chargeable in principle but hold-over relief can be claimed. The gain without relief would be £400k. As the consideration of £300k is less than the base cost of £550k the whole gain can be held-over. This will prevent any future PPR claim by the trustees if the settlors retain an interest under the trust. So the parents must be excluded but the children are OK if over 18 and the widow or widower of the settlor is OK. Two trusts will make the last issue easier to defend. I have no idea what HMRC would make of a single trust with joint settlors. The drafting would be tortuous.

4 The debt for the price can be assigned by way of gift to the children and will be a PET. If one or both of the parents die within 7 years there will be a charge to IHT without NRB but subject to taper relief after 3 years. and again possible gift insurance. This highlights the need to consider the terms of the debt. If it is interest-free it can be a demand loan but if it is for a fixed term at a nil or below market rate the loan would be discounted for IHT in valuing trust assets for IHT trust charges; although that will also reduce the transfer of value for the PET and in the children’s estates.

The clients should be made aware of the effect of the nature of the characteristics of any debt, principally that the trustees begin by owing money they cannot repay without selling the asset or transferring a part interest in it to the creditor. In fact as all in all this is a sophisticated arrangement it is vital that the clients and their children fully understand how it works, have a written plan for administering it, and how it might be affected by the most likely changes in circumstances.

5 Technically it is possible to distribute the property to the children after 6 months with no IHT and PPR for CGT. The latter is fraught with all the usual difficulties of providing the evidence that is has become the only or main residence of at least one beneficiary. The trust should explicitly state that this is its purpose. It will be a question of fact and if the child in fact lives elsewhere may be difficult to substantiate. There is no election between two residences if one is owned by trustees.

The distribution will be a sale for SDLT for the amount of debt discharged by the creditor.

6 Will it work? The effect of the arrangement in total is to allow the parents to make a gift of the whole property either without CGT or, if a PPR claim is unsuccessful, then at least with hold-over relief which would be unavailable for a direct PET. The GAAR raises its ugly head. It is not just a matter of timing but just 6 months is unhelpful. This kind of operation is liable to be sabotaged by actions events and statements made prior to its inception. Also HMRC seem to think that they can discern even the unspoken and unwritten intentions of taxpayers.

For example, if the property is sold shortly after its distribution recent historic attempts to market it will become a problem. The clients need to have the stomach and wallet for persuading an opposing HMRC, and for losing, as well as the costs of the arrangement even if it is counteracted. All HMRC need to do is say: “GAAR, no reliefs and the counteraction is a direct gift with CGT”. This would be an own goal of £112,000! Unless they are willing take on such a formidable foe. Even if the advice about implementing the arrangement is protected by LPP HMRC may argue that this does not prevent the ascertaining as a fact whether it was given in request to avoid tax on a sale. If the adviser is not within the ambit of LPP e.g an accountant or scheme merchant they can see the advice itself.

Genuine occupation by one or both of the children for a much longer period will go a long way to disarming the GAAR.

7 Finally, the question should always be asked whether there are better alternatives. One of these is doing nothing, at least if it is not the intention to sell soon. The property could be left by will to the surviving spouse and again by the survivor to the children. On the first death there is an uplift in base cost to market of 50% of CGT market value and no IHT and on the survivor’s death a 100% uplift and for IHT 2 NRBs. Or he/she could make a PET with a 50% enhanced CGT base cost. Although IHT is 40% CGT is 28% and it is possible that the saving of CGT will sugar the pill of IHT.

Jack Harper

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Dear Jack

I greatly appreciate your detailed and thoughtful response!

One of the kids does have the intention to reside in the property in the future so I am hopeful that this will help to steer away from GAAR.

In terms of alternatives, apart from leaving the property to the surviving spouse, I was considering the following:

Transfer £650k of the property into the Discretionary Trust at Day 1 (using the NRB of both parents), and the remainder £350k of the MV is transferred to the Trust after 7 years (concluding the full transfer of the property into the Trust). Following this, after 6-9 months, the property in full is transferred to the kids. The Trust deed will explicitly state that residence by the beneficiaries is the main purpose.

The parents are aged 57 and 59. They will have to survive 14 years to avoid the claw back of the NRB, but this could be mitigated by insurance. This is a gradual way of passing the property onto the kids and is less aggressive than my original plan. I would appreciate your thoughts on this.

Regards
Abdul
Stratton Tax

A good plan. As property in a RPT is not “related” the trust property and the retained part will each benefit from a 10-15% valuation discount until the second gift: https://www.gov.uk/guidance/inheritance-tax-manual/practice-note-2-undivided-shares. That should be made into a separate trust, even though the first gift will not fall within s67 IHTA as added property and two new NRBs will become available. It will have its own 10 year intervals and the possibility of a distribution tax free in the first 10 years, though there may instead be a small cost because what is worth ££350k now could exceed £650k at the second gift.

I agree that if the genuine residence of the child endures for a long (imprecise!) period PPR should deal with the CGT exposure of the child on a sale. The plan does forgo uplift on death of the parents or the child on the portion first gifted for 7 years and on the rest for another seven; but each held over gain should attract PPR and GAAR should not be in point as there is nothing fancy or objectionable in the tax planning even if the property is sold with PPR, especially if there is a non-tax reason for the sale. For SDLT this will not prevent the child from later being a first time buyer of a different property though the £500k limit may do so.

I should emphasize the need to avoid a GROB. Not just at the outset but at all times in the period of 7 years before the donor’s death. See IHTM14333 for HMRC’s approach. As long as no reservation subsists at the time a full distribution of the trust property or its sale proceeds breaks the chain of the tracing rules. Once 6 years have expired from the date of disposal hold-over relief cannot be clawed back; during that period some degree of occupation by the settlor or spouse might not even be breach of trust (not a point open to HMRC to take) but full time occupation, even though still not breach of trust, might be a “benefit” within s169F. It must not be part of the original pan or it would prevent initial relief as an “arrangement”. There is no statutory disregard for CGT as there is for an IHT reservation in para 6 Sch 20 FA 1986. After a full distribution 6 or more years after date of disposal CGT clawback and GROB rules cease to apply.

Many trust precedents include a power for the trustees to add a beneficiary. This should be excluded unless it is modified to prevent the settlor and living souse from being added. This can easily be overlooked when the trust property will not be income producing so that the routine exclusion for income tax is not essential

Jack Harper

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