Mark McLaughlin
CTA (Fellow) ATT TEP, General Editor of TaxationWeb, selects a 'question of the month' from TaxationWeb's Forum

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September 2006

Introduction

This month's Tax Clinic concerns a request for Capital Gains Tax (CGT) and Inheritance Tax (IHT) advice on the purchase of a residence owned by the individual's mother. The query suggests that the daughter and her family have moved in with her mother, who wishes to sell the property to her daughter for less than market value

Q:

My husband, children and I have been living with my mother for the last 5 years. It was only a temporary arrangement at first. Now my mother is 74 and has made it clear she does not want to go back to living on her own, or end up in a nursing home. She has suggested selling the house to us under its market value, so we can afford it. She would benefit from the money and by knowing we will be there in her later years.

The house is worth around £140,000 but in a bad state of repair. She has suggested we buy it for £50,000. We would need to borrow another £40,000 for the repairs and an extension as we are a bedroom short. When completed the value would be around £200,000. Obviously, this makes great financial sense for us as, but I am concerned about Capital Gains Tax (CGT) and Inheritance Tax (IHT). I don't where we would stand on either. Any advice would be greatly appreciated.

A:

Editor's Comments

The query instinctively recognises that there are CGT and IHT issues involved in a sale of the house at undervalue. For CGT purposes, mother and daughter are 'connected persons', and disposals between them therefore take place at market value (estimated at £140,000), regardless of the actual consideration paid (i.e. £50,000). It is not stated in the query whether the disposal triggers a capital gain. However, assuming that a gain does arise, mother should be to claim CGT relief if the property has been her only or main residence throughout the period of her ownership.

As one of the contributor replies below indicates, the IHT position is rather less straightforward. A sale at undervalue between individuals is a potentially exempt transfer (PET), which only becomes exempt if mother survives at least seven years from making the gift. In addition, there is an effective gift element to a sale at undervalue. Because mother continues to benefit from the 'gifted' property, the IHT anti-avoidance rules regarding 'gifts with reservation' (GWR) need to be considered. Where the GWR provisions apply, the gift element is taken into account in the donor's death estate. There is a potential exception from the rules in certain circumstances involving gifts of interests in land. However, in this instance the whole property is being sold. There is relief from a double charge to IHT as a result of the PET becoming chargeable on death within seven years and the gift element being included in the death estate.

A GWR could be prevented by paying a market rent for continued occupation. This would reduce mother's estate for IHT purposes, but create an income tax liability for the daughter.

However, even if the GWR rules do apply, is this necessarily going to result in an IHT liability? The query does not state the size of mother's estate. If the value of the estate (including the GWR) combined with any gifts in the last seven years do not exceed the nil rate band (£285,000 for 2006-07), then the fact that there is a GWR does not create an IHT issue in mother's estate.

The query does not consider the possibility of an income tax charge under the 'pre-owned assets' rules, or whether there are any implications for state benefits purposes (if applicable). All in all, this is a tricky question from xSUEx, for which specific professional advice should be sought based on the full facts.

Responses from contributors included:

Lawrence McAuley01:

I don't think there is any CGT issue on the gift. In the first instance, market value will be put in the place of the actual price paid, but that doesn't matter because this is your mother's residence and is therefore CGT exempt.

The inheritance tax side of things is more complex. There is no immediate charge to IHT. However, because of the 'discount' and the fact that your mother will be staying in the property, you have a potentially exempt transfer and a gift with reservation of benefit. None of this is important if your mother's IHT estate is below the nil rate band (presently £285,000), but if you are hoping to save IHT through this arrangement, you should take detailed IHT advice.

mathsboy:

Surely the SDLT bods would have something to say about their loss of £1,400?

Lawrence McAuley01:

Not a pet area of mine, SDLT, but I don't think there is a problem there. The consideration is £50,000 not £140,000. Unless xSUEx and family are taking over a mortgage from Mother, then the consideration is in the 0% band. I don't believe market value has to be substituted in the way it does for CGT.

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