Vacation Homes and Estate Tax Planning
Clients who are considering buying a holiday home often ask us whether they should buy it in their own name or on behalf of their children. Clients who already own a holiday home also ask us if they can reduce their inheritance tax bill by gifting the property to their children or putting it in their joint name with that of their children. So what are the tax implications? Many clients only think in terms of inheritance tax, but income tax, capital gains tax and property tax also need to be considered.
Main tax issues
- Inheritance Tax (IHT) – Gifts of this type can very easily fall under the Gift with Reserved Benefits (GROB) rules. These rules mean that if a person continues to use or benefit from a property after donating it, HMRC considers the person to have not actually made the gift, so the full value of the gift remains subject to the IHT scheme and potentially dependent on the IHT in their estate
- Income Tax (IT) – Even if a gift successfully avoids the GROB rules, it may be caught by the Used Assets Tax (POAT) rules and result in an unwanted annual IT bill
- Capital Gains Tax (CGT) – The gift of property, or a share thereof, is treated as a sale at its free market value for CGT purposes, so there could also be a CGT liabilities. For those who buy a vacation home with money, this is not a problem, but those who have an existing vacation home must take into account the amount of the gain from the date of acquisition and the date of the donation.
- Stamp Duty Land Tax (SDLT) – There may also be SDLT implications for grant recipients.
Angela and Barry are a married couple in their sixties. They have two adult children, Christine and David, who are married with young children. Angela and Barry recently bought a holiday home in Cornwall for £1,000,000 and would like to give some or all of it to their children to help with IHT. It is intended that the holiday home will be available for use by the whole family and not commercially rented out.
Inheritance tax and income tax
It is possible to avoid the GROB (and POAT) rules by ensuring that the donation falls under a specific exemption from the IHT rules (known as a “co-ownership exemption”). This applies when one or more persons (the Donors) donate to one or more other persons (the Donees) a share of property and:
- Donors and donees both “occupy” the property
- Donors receive no benefit, other than insignificant, from Donees for any reason related to the donation.
So if Angela and Barry give a 25% share to Christine and David, that would potentially fall under the co-ownership exemption. If it falls under the exemption, the POAT rules also don’t apply.
This type of planning is not considered by HMRC to be aggressive planning unless the percentage of the property given away is excessive. HMRC guidelines are that any donation over an equal share will always be investigated.
To ensure that the gift falls under the co-ownership exemption, Christine and David must “occupy” the property along with their parents. Although the term “occupy” is not defined in the legislation, it is clear that this does not mean that Christine and David must live in the property as their principal residence. However, they would each need to have free access to the property, for example, they would each need to have their own key and leave some of their own belongings at the property permanently. Ownership documents should also reflect the new co-ownership agreement, including notification to the local council tax authority and building and contents insurer.
If the co-ownership exemption is met and Angela and Barry survive the donation by 7 years, the donations would not be subject to IHT upon their death. If one of them does not survive for 7 years, there may be an IHT on the donation of their 25% share, depending on other previous donations they may have made during their lifetime.
The absence of benefit requirements
It is important to consider how the ongoing costs of ownership are going to be covered. It’s okay if Angela and Barry keep paying all the fees – as often happens in families. There can then be no argument that Angela and Barry receive any benefit (as long as Christine and David do not in turn pay other bills for their parents unrelated to the property).
If Christine and/or David are contributing to the running costs, it is wise to err on the side of caution and for Angela and Barry to continue to ‘overpay’ their share of the costs in order to avoid any challenge to the arrangement by HMRC, on the basis that Angela and Barry somehow get an advantage.
Remember that it is essential for this planning to work that the no-benefits requirement is met for the entire term of the joint ownership, not just the first 7 years.
Potential future issues of IHT
If Christine and/or David cease to occupy the property at any time, the protection of the co-ownership exemption is lost and a reserve of profit would arise. This means that the value of their share in the property at that time, and which may have increased in value, is rolled back into Angela and Barry’s estates for IHT, defeating the planning. This would be the case even after the 7 years have passed since the date of the donation.
Capital gains tax
As long as Angela and Barry donate a share of the property to Christine and David shortly after its purchase, CGT liability is unlikely to arise, although they may need to report the donation to HMRC. However, if Angela and Barry had owned the property for longer and its value had increased since they originally purchased it, CGT liability could of course arise, currently at a tax rate of 28%.
Land tax on stamp duty
Here are some issues to consider:
- Giving a share in a property to someone who does not already own a property is likely to prevent them from qualifying for first-time buyer’s allowance
- If they don’t already own a primary residence, this also means they will have to pay the additional 3% SDLT fee when they purchase their primary residence. If they already have a principal residence and are replacing it, the surtax will not apply
- Disposal of a share of real estate with a mortgage may also give rise to an SDLT liability.
Although the example above is for a property in the UK, nothing prevents the co-ownership exemption from applying to a property abroad, such as in Spain or France. Such gifts would require careful consideration, as not only do tax issues in the UK need to be considered, but also tax and estate issues in the other country.
Whether your property is in the UK or overseas, you need to consider further the tax implications if you intend to let the property.
As an alternative, Angela and Barry could assign the entire property to Christine and David and avoid GROB rules by paying full market rent for their use of the property. This can be a good option under the right circumstances, but it can be very costly both in terms of rent expenses (which are then forced into the hands of the children) and ensuring that adequate proof of residence is obtained on a regular basis. a market rent. base.
The pure and simple donation of a share in a second family residence can, if the conditions are met, be a relatively simple and effective way of reducing the size of your wealth for the IHT.
But as always, don’t let the tax tail stir the dog. You will also need to consider what would happen if one of the beneficiaries predeceases you or experiences marital or financial difficulties, or if your own financial situation changes. Any form of giving or planning requires careful thought and sound advice.
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.