In writing this note my call to action is to ask readers who may want to embark on UK Inheritance Tax planning on their second home – in or outside the UK – to come and see me
As a solicitor specialising in UK tax law I am recurrently surprised that people who live here (UK tax residents) are unaware that the default position is that they are liable annually to UK tax on their worldwide income and gains.
As HMRC says in guidance issued in November 2017 on correcting [UK] tax due on offshore assets ‘anyone who owns or has an interest in assets held offshore or has had a source of income that is offshore, or has moved income or the proceeds of capital gains offshore is potentially affected’ by a liability to UK tax/an obligation to correct an incorrectly submitted prior UK tax return.
I want in this note to tell a story that comes up not infrequently relevant to individuals who own a second home outside the UK. I conclude by saying there is a wholly legitimate way to embark on inheritance tax planning for second homes that is within the Inheritance Tax legislation and ‘does the job.’
Mr X who owns a home in Spain personally and wants to mitigate Inheritance Tax on this asset by transferring it to his 3 adult daughters. The Spanish property is important to Mr X and all his family and all intend to use it after the gift.
Mr X is told in Spain that if he makes the intended gift he can enjoy a usufruct (a right to use) for his lifetime and for Spanish purposes won’t have to pay any rent or worry about who pays the utility bills etc after the gift. He is also told for Spanish Capital Gains Tax purposes there is one value for the property which is accepted in Spain in the case of ‘donations’ and this is divorced from anything to do with market value.
The UK advice Mr X receives is that
- the UK regards the creation of a usufruct as a transfer into trust on which IHT is due if the chargeable transfer by Mr X exceeds £325,000;
- for Capital Gains Tax purposes the UK will deem Mr X to have realised market value when he transfers the Spanish property to the usufruct. He will be liable to pay UK Capital Gains Tax on his gain even though he has received no cash; and
- for Inheritance Tax purposes, assuming he enjoys the usufruct within 7 years of his death, he will be treated as having reserved a benefit in the Spanish property and its value will be in his estate on death.
The approved Inheritance Tax route
The Inheritance Tax legislation has an exemption from the gift with reservation anti avoidance rules called the co-ownership exemption.
The co-ownership exemption applies when the donor and the recipient(s) occupy the land; and the donor does not receive any benefit other than a negligible one, which is provided by or at the expense of the recipient(s) for some reason connected with the gift. Occupation, but not necessarily as a family home, is required
Tony and Cheri own a seaside property in Deal which they acquired many years ago for £70,000. It is now worth £300,000 and does not benefit from Capital Gains Tax main residence relief (Tony and Cheri elected for their London property.) They wish to give a share of the Deal house to their 2 adult children who use it during the summer months. The objective is to have the property owned as to 25% each by Cheri and Tony and their 2 children. Each co-owner comes and goes as they please; leaves possessions in the house; has their own bedroom and a set of keys. For each child it is a second home
The co-ownership exemption from Inheritance Tax will apply provided that all co-owners occupy the Deal property. On the facts above this should be the case.
The gift by each of Cheri and Tony is an Inheritance Tax potentially exempt transfer which will be outside each of their estates if each survives the gift by 7 years.
As regards expenses at a minimum Tony and Cheri and their 2 children should split the running costs of the Deal property 25% each. If Cheri and Tony can afford it there is no Inheritance Tax reason why they cannot continue to meet all the running costs. The 50% they meet for their children will be within the scope of Inheritance Tax but may be exempt from charge either under the Inheritance Tax annual exemption or as a gift out of income.
The gift by Cheri and Tony will be a disposal for Capital Gains Tax purposes and these implications will need to be considered and understood. It may be the charge to Capital Gains Tax can be deferred/’rolled – over.’
The above Inheritance Tax planning has issues if for example a child of Tony and Cheri’s dies before their parents and/or if Tony and/or Cheri cease to occupy the Deal home because they go into a nursing home. With planning, should these facts present, the Inheritance Tax issues that arise can be overcome.
If you would like to discuss anything raised in this note, please get in touch.