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Having Your Inheritance Cake And Eating It

Having Your Inheritance Cake And Eating It

Many families own a holiday home. Often this is passed from generation to generation, with all the extended family using the property, sometimes separately and at different times of the year. However, there can be problems in passing ownership efficiently for Inheritance Tax (IHT) purposes.

One of the most efficient forms of IHT planning is to make a gift of an asset and then survive for 7 years. However, where any benefit is reserved in making the gift, the value of the asset is still included in the donor’s estate for IHT purposes on their death. Gifting a holiday home to the next generation and then continuing to use it on a regular basis would be one example of reserving a benefit. While there are solutions to this problem, for example, paying a market rent for use, this may not be affordable or attractive to the donor, particularly as the rent will be taxable in the hands of the new owner, who could be a higher rate income tax payer.

One solution is to pass the holiday home into a trust. Trusts have fallen out of favour in recent years, particularly since 2006 when the taxation of trusts was fundamentally changed and the majority of trusts brought within the ongoing inheritance tax charge regime. However, in the right circumstances they still have their place to play in inheritance tax planning.

Gifting a house to trust and then continuing to use it will still fall within the gift with reservation provisions detailed above. The key here is to transfer the house to a trust at a suitable point and then hold it in the trust on an ongoing basis. A suitable point would, for example, be the death of an owner.

Where the holiday home might pass to the next generation at this point, the alternative would be to pass it into a discretionary trust with the beneficiaries being the extended family. The advantage of this is that the home is then not comprised in the next generation’s estate for IHT purposes and can remain in trust for years to come. There are potential small IHT charges every 10 years but generally the first £325,000 of assets will not incur a charge to IHT so a trust may be particularly suitable for properties worth less than this sum.

Having a property in trust can be advantageous for other tax purposes. A beneficiary who inherits part of a holiday home before they purchase their own main residence would have to pay an additional 3% Land and Buildings Transaction Tax (the Scottish equivalent of Stamp Duty Land Tax) on the subsequent purchase price of their first home. Passing the holiday home into a discretionary trust avoids this problem.

For taxpayers who have already inherited a property, but within the last 2 years, it may be possible to use a Deed of Variation and pass the property into trust through this method. Deeds of Variation are effective for IHT purposes so the disposal would be seen as being from the deceased’s estate rather than the beneficiary.

For more information on effective IHT planning for holiday homes please get in touch.

By Claire E Macpherson
Director

Burness admin