I want to buy a house for my children, where they they live rent free, what is the best way of doing this?
Garner & Hancock can advise you on saving capital gains tax (CGT) on buying a second property for your children.
A loophole remains (unless the tax man in the next budget closes this) a wholly legitimate way to buy another property and subsequently dispose of it without having to pay any CGT. The added advantage is that your full CGT exemption on your own home is unaffected.
We at Garner & Hancock are increasingly advising parents about such schemes as rising property prices put home ownership out of reach for many starting their career or getting hitched. Parents often want to avoid the obvious money pit of costly rental market – and save for a deposit.
The answer is setting up a Trust. This word sends shivers down most people as being expensive or only for the rich. However quite to the contrary, the savvy buyer now looks at such things just like you would life insurance. It is also relatively inexpensive to arrange. A Trust can also be used where you have owned the property for some time
Garner & Hancock can take you through the process step by step.
When thinking about buying a property, it is best to approach us to discuss setting up a formal written trust. This can with one or both parents named as the trustees.
So once the Trust is set up, you fist loan the trust the deposit and it is the Trust that takes out the mortgage. When you speak to your IFA tell them that this is what you are thinking so that they get the right mortgage for you. The mortgage company will usually ask for a guarantee. This is quite normal and we can look at the terms of the mortgage for you.
Here are some types of Trusts which may fit what you are looking for:
A “life interest trust” allows you to name a single child as a beneficiary, and that child also has a right to the income from the property.
A “discretionary trust” allows you to name any number of children or indeed family members as beneficiaries. Although with a discretionary trust there is no automatic right to income unlike the life interest Trust but you can structure it in this way if you choose.
With both types of trust, the named beneficiaries can become what are called life tenants, which gives them the right to live in the property rent-free.
A discretionary trust is a more flexible arrangement because one child could occupy the property whilst they are at university, for example then another beneficiary could could take over the property at a later date. There is no limit to the number of times the occupier can change, as long as they have the right to occupy the property rent-free under the terms of the trust.
How does the CGT savings come about?
Each beneficiary can trigger their own “principle private residence relief” when they move into the property and since CGT is exempt to homeowner’s, you do not have that fear of having to pay a hefty CGT bill when you come to sell. As long the property has been occupied by at least one of the named beneficiaries at all times the above relief will wipe away any CGT gains.
At the same time your own principle private residence relief on your home is not affected. A further tax relief is on income tax. No income tax is due when you sell. Remember you cannot charge rent to the occupiers/beneficiaries and If you rent/let out the property during this period there will be income tax issues see below.
You must sell within 18 months before a capital gains tax liability would start to accrue. Within this 18-month period you can let it out to any tenants you like and it will not affect the CGT exemption.
Outside of the 18-month period, if the property is not occupied by a named beneficiary, CGT may be due for that period.
I have already purchased the property, can I still use a Trust?
You haven’t necessarily missed out on this valuable tax advantage. There are occasions where a trust can be “implied”, even when a trust deed was not set up at the time the property was purchased. The capital gains tax relief can still apply in what is known as an “implied trust”.
If your children have been living in the property and benefiting from the arrangement, HMRC will want to see that the arrangement operated in practice in exactly the same way that a trust would have.
You could have for example have flat mates live at the property but you would have to pay income tax, but there are ways to minimise the tax owed.
How this is treated will depend on the type of trust you have set up and where the rent is paid.
If the rent is paid to the trust: you should notify HMRC that you have set up a trust that will receive rental income, and register it for self-assessment. This is an important step even if you are already personally registered for self-assessment, as a trust is considered a separate legal entity.
A life interest trust, where there is just one named beneficiary, will have to pay 20pc on the rental income, after expenses and the mortgage interest have been claimed (please note this is being reviewed by the Tax man currently).
A discretionary trust on the other hand must pay 45pc tax on the rental income, after expenses.
As a trustee can pay the income to your child as the beneficiary. If they have no other earnings their personal tax allowance of £10,000 will be intact and they can claim the tax back from HMRC up to this limit.
If the rent is paid to the child: your child can receive the net income as the life tenant. It is essentially the same as if they had purchased the property in their own name, received the rent and paid the expenses and mortgage interest personally.
He will have to register for self-assessment, and can claim the same expenses as above to reduce his tax liability.
A Tip is to write to HMRC that you are giving your child an income under a Trust, and ask the taxman to agree with them that your child need not complete a tax return.
What about inheritance tax on discretionary or life time trusts.
Since the initial money (deposit) is given to the trust by you as a loan this will not create any liability for inheritance. Although you need to be aware that if you loan more than the IHT limit of £325,000 (2015/2016). This is called settled assets. In a case where you have loaned more than this amount to the trust then a 20% IHT charge would apply to the excess.
What other tax do I have to pay on the Trust?
Any trust that owns property must also pay inheritance tax every 10 years at 6pc on any value above the £325,000 threshold. The HMRC website has clear examples of how to work this out CLICK HERE
To avoid this annual charge you could have simply gifted this to the trust, this will not usually trigger a charge. But be careful there are special rules about gifts. See the HMRC guide on this CLICK HERE
There may also be a charge to IHT when the entire trust or part of it is distributed to one or more beneficiaries. This will depend on the aggregate value of the distributions made during the last ten years of the trust. The top rate is again 6%. See the HMRC guide on this CLICK HERE
If one or both parents as the trustees die, new trustees can be appointed and the trust can carry on as normal. Alternatively, if the trust is set up so the children inherit the property on death, the normal inheritance tax rules apply.
What do you have to do to be a trustee of a Trust?
To be a Trustee you need to be know the traps and obligations. We think the Government guide is one of the best and easy to understand publications and its free. CLICK HERE
In summary, to be a trustee you need to:
- take decisions for the best interest of the Trust and record these decisions,
- keep good records,
- protect the assets and what is necessary to do this,
- make Tax Returns and pay the correct amount of Tax.
Garner & Hancock can advise you on all aspects of creating a trust.
- We can help you administer the Trust and help and guide the Trustees
- How to distribute assets from the Trust
- Advise on the taxation of the trust
- Complete on your behalf the annual tax return
You should always seek specialised Tax advice from an accountant and look at all your options in you making financial planning with an experienced IFA.
This article is for guidance you should always seek legal advice before you consider these options.
If you want to discuss any of these matters please speak our private client department at Garner & Hancock Solicitors
If you would like some help or advice, then please feel free to call to arrange a conversation on 0208 232 9560, or drop us a note using the form below and we can book you a call with a solicitor.