Donation and sale-leaseback agreements: inheritance tax planning with the family home
For many, the family home is the most valuable asset they own. It is also often the last asset to consider when planning inheritance tax (IHT). For landed property owners, the family home is often the focal point of family, community, and business activities of the estate itself, perhaps for many generations. This doesn’t make planning impossible, but does mean that a myriad of practical and tax issues need to be considered before anything is done.
Entering into a gift and leaseback agreement is not for everyone, but when done correctly, it allows a person to continue living in their family home while ensuring that the property is removed from its domain for IHT purposes. For property owners, this must be done carefully, ensuring that the tax treatment of the home itself and surrounding assets (eg farm and commercial land) is not compromised.
What is a gift and leaseback agreement?
An individual (or couple) makes an outright gift of their property to someone else (often a child or children) or into a trust, with the recipient leasing that property to the property owner(s). origin at an agreed market rent.
If ownership is given outright to an individual, this constitutes a potentially exempt transfer for IHT purposes. There is no IHT payable immediately upon transfer, or on the death of the original owner if he survives the gift for seven years. A gift in trust will generally incur an immediate IHT charge of 20% of the market value of the property to the extent that it exceeds the zero rate band available (currently a maximum of £325,000 for a sole proprietor and £650,000 for a couple), but otherwise the situation is the same.
Donation-leaseback has a double impact on the value of an individual’s assets. First, continued rent payments will gradually reduce the value of the estate and the subsequent liability of the IHT. Second, provided an individual survives seven years from the date they donated the property, the value of the property will be removed from the estate in full. Tapering relief is available when a donor does not survive seven years, so IHT benefits generally begin accruing three years after the donation.
A gift in trust has an added advantage because the property belongs to the trustees rather than the outright recipient, so there is an extra layer of protection in the event of a divorce or bankruptcy in the family. If, like many large farms and estates, the surrounding land is already held in a trust structure, there could be practical advantages to having the property in one place, such as providing a single entity for employment workers in the domain and the plant. management of maintenance contracts.
What are the pitfalls?
- The most common failure is where the gift is covered by the Gift with Advantage Reservation (GROB) rules and is therefore ineffective for IHT purposes. A GROB can arise in a number of circumstances, most obviously when someone transfers an asset but retains use and enjoyment of it without payment of full consideration.
It is therefore essential that when an individual sells real estate, he pays market rent to the new owner. This must be negotiated on arm’s length terms, fully documented and backed up by appropriate appraisals and professional advice as to the level of rent paid. If the donor continues to live in the property without paying full market rent, the “seven-year clock” for IHT purposes does not start to run. This of course requires considering, from a cash flow perspective, whether the person paying the rent has sufficient cash or income reserves to continue paying the rent until death. For this reason, a gift and leaseback is often more suited to be a relatively short-term rather than a long-term agreement.
- The individual must continue to pay market rent throughout, not just for 7 years. The rent must therefore be reviewed every 2 to 3 years. If not, GROB rules can bring the property back into the donor’s estate, regardless of how old the original gift was.
- The gift of the property will be treated as a disposal for capital gains tax (CGT) purposes. Where the property in question has always been the principal residence of the owner, it would normally benefit from the principal private residence (PPR) exemption under the CGT, in which case no CGT would be due. A gift in trust may be able to take advantage of surplus relief, which allows CGT to be deferred, if PPR is not available. However, where a property has multiple units (eg apartments and/or cottages) or extensive land, the position of the PPR should be carefully considered to ensure that a CGT load will not occur. If a second home is owned, care should be taken to clearly identify which property will attract PPR.
- For farms and estates, it is essential to determine whether the donation will adversely affect the treatment of surrounding land for IHT purposes. For example, if the property is the central hub of agricultural operations, it could be exempt from IHT in all cases under the agricultural property relief provisions. The most suitable properties for this planning are likely to be those which are owned separately from surrounding land and/or where business activities are conducted from a different location, for example the real estate office. Each situation will be different, so individual circumstances should be carefully considered.
- The granting of the lease may also give rise to a land stamp duty (SDLT), depending on the level of the rent and the duration of the lease. However, the SDLT is generally not significant compared to the potential tax savings.
- The rent, net of expenses (such as insurance, maintenance and repairs) will be subject to income tax in the hands of the beneficiary. Depending on the beneficiary’s tax situation, this can lead to rental income being taxed at up to 45%.
Who should be involved?
Since the transaction must be conducted at arm’s length, it is important to seek expert advice on the various aspects of the transaction. This includes but is not limited to surveyors or land agents to ensure a market rent is agreed, lawyers/tax advisers for private clients to advise on estate planning and tax aspects and real estate lawyers to manage the transfer of ownership and subsequent consequences. sale-leaseback.
Gift and leaseback agreements not only apply to bricks and mortar, but can also be used in connection with heirlooms and valuable personal property. The same principles apply and a market rent for movable property must be negotiated. HMRC scrutinizes chattel provisions carefully, as there is often no ‘real world market’ for chattels, so great care must be taken.
Grant and leaseback agreements can be a very effective mechanism for reducing your IHT liability if they are put in place correctly from the outset and regularly reviewed. The costs of implementing such an arrangement are generally modest compared to the potential tax savings. This planning is generally accepted by HMRC, provided the arrangement is carefully planned, executed and monitored.
This article is provided for general information only and reflects the law as of the date of publication. It does not constitute legal, financial or other professional advice and should therefore not be relied upon for any purpose. You should consult a suitably qualified attorney or other relevant professional on a specific issue or matter. Please see our terms and conditions for more details.