Tax Doctor:
Mark McLaughlin
ATII ATT TEP

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September 2003

Q:

My Husband and I live in a property worth £175,000 (held in my name). We are considering buying my elderly father, age 90 a retirement property, worth about £150,000 and would finance the purchase partly from savings and partly a Halifax mortgage. We were concerned about the possible Capital Gains Tax and Inheritance Tax implications. We would continue to live in our present property. Can you offer any advice, please?

A:

You state that you and your husband are buying the retirement property, indicating that you will be the owners. You would continue living in your present home, so the retirement property will be a second property. For Capital Gains Tax (CGT) purposes, any increase in the value of your father’s new home between buying and selling it will therefore be taxable.

You and your husband will presumably jointly own your father’s home. You are each potentially entitled to the following in respect of a gain on the property:

• An annual CGT exemption (£7,900 for 2003/04), provided that the exemption is not otherwise used against chargeable gains on other assets in the same tax year;
• If you own the property for at least three complete years, you will be entitled to deduct ‘taper relief’ from any gain on disposal. Taper relief reduces the potential gain by 5% after three years, increasing by 5% in each subsequent year up to a maximum of 40% after ten complete years of ownership.

Do you own your existing home outright, or is it mortgaged? If you own it outright, and if the potential gain on your father’s home is a worry, there may be an alternative. You may wish to consider buying the property and then transferring it to your father. You are unable to do this if you are obtaining a mortgage secured on the property, but you could perhaps re-mortgage your home instead to raise the necessary equity. Your father would then live there for the rest of his life, and presumably leave the property to you in his will. On his death, for CGT purposes you will inherit the property at its then market value, not the value when it was originally acquired. Your father’s estate is not liable to CGT on his death, although it is potentially liable to Inheritance Tax (IHT).

Inheritance Tax

If you and your husband own your father’s property jointly, it will ultimately form part of your respective estates for IHT purposes. If the value of your estates exceeds the ‘nil rate band’ for IHT purposes (£255,000 for 2003/04), there is a potential IHT liability on the last of you and your husband to die (this assumes that on the first death everything is left to the surviving spouse, and that you are domiciled in the UK), as transfers between spouses are IHT exempt. Since you are the sole owner of your existing home, it is quite likely that the value of your estate already exceeds £255,000. Transferring a share in the property to your husband and occupying it as ‘tenants in common’ may increase flexibility and possibly open up opportunities to save IHT (e.g. by allowing a share in the home to pass to someone other than the surviving spouse on the first death), but IHT planning involving the family home is a whole subject on its own, and there are various reasons why this type of planning should only be considered as a last resort in my view.

On the other hand, if your father owned the property it would form part of his estate instead. It may be the case that the value of his estate, including the property, is covered by his IHT nil rate band on death. It may be useful to maintain an inventory of his estate, particularly if property values continue their upward spiral, in case the nil rate band is exceeded.

A gift of property (or cash) to your father will escape IHT completely if you survive at least 7 years after making it. Should you die within that time, the extent of any IHT liability broadly depends on whether your estate, together with the value of taxable gifts made in the preceding 7 years, exceed the IHT nil rate band. IHT of 40% is potentially payable on any excess over that limit.

If your father leaves the house to you in his will, the property will form part of your estate once again. If your father’s estate, including the house, does not present an IHT problem, one possible solution might be to give your father a ‘life interest’ in the property. This can be achieved through a relatively simple trust deed. You still need to survive at least 7 years after making the original gift, to avoid any potential IHT liability. However, on your father’s death, the property could pass by trust to another beneficiary of your choice, or it could remain in trust for someone else’s future enjoyment. This has the added advantage of a potential CGT free uplift. Much depends on personal circumstances and estate values, and specific advice is recommended before proceeding.

Mark McLaughlin

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