The soaring value of family homes means that many pensioners are living inside a potential tax liability.
The number of people in the UK paying inheritance tax jumped by 24 per cent in the past year, with 41,000 estates caught in the IHT net — nearly double the number three years ago.
Should this trouble members of the older generation happily living inside their biggest asset? IHT bills are not their problem. The problem of sorting it all out falls to the younger generation, but they are seeking the advice of tax planners in ever-increasing numbers.
Devising a property strategy for relatives in their later years is not solely about reducing IHT bills, it’s also motivated by how best to care for them.
FT reader Pauline is a case in point. Her 83-year-old mum is still as sharp as a pin, but struggles with mobility. She lives alone in the former family home in Brixton, south London. Bought for a song in the 1970s, it is now approaching £1mn in value.
Pauline would find it much easier to care for her mum if they both lived under the same roof. Moving in with her mum isn’t an option, and her current home isn’t suitable. So they’ve talked about joining forces and buying a property with an annexe or granny flat.
However, Pauline soon hit the brick wall of inheritance tax, an increasingly common problem. I’ve been speaking to tax planning experts about the financial and emotional aspects families need to bear in mind.
Work through the ‘what ifs’
You may be keen for your relative to sell up to avoid IHT. They, on the other hand, may be very keen NOT to!
“Do not underestimate the emotional impact of losing control of the roof over your head,” says Sally Ashford, partner at law firm Charles Russell Speechlys. “It might make perfect sense from a tax point of view, but older people can feel very vulnerable.”
She advises her clients to work through a long list of “what ifs”.
“What if you move in together, but fall out with your child? What if you need more care than they can provide? What if your child’s marriage breaks down, or if they die — will your position be protected? And what happens if one of you wants to sell, for whatever reason?”
She has seen examples of multigenerational living working out well, and some clients have saved “substantial amounts” of IHT. But there is also high potential for disputes, especially if multiple siblings — all of whom could potentially inherit — are involved.
“Tax shouldn’t be the driver of any decisions. Decide what you want to achieve first, then get advice to work out the most tax-efficient way of doing it,” she says.
Now, for the tax issues
If Pauline’s mother died tomorrow, the family would face a potential IHT bill of £200,000 on her £1mn home. Advisers say the numbers often come as a shock.
All adults have a nil rate band of £325,000 and many — including Pauline’s mother — also benefit from a £175,000 residence nil rate band. Spouses can transfer this allowance between them upon death, meaning up to £1mn can be passed down free of tax, but Pauline’s mum is not a widow — she’s divorced, so her ex-husband’s allowance went with him. When she dies, 40 per cent tax would be charged on the rest of her estate.
“Options to mitigate IHT bills when the family home is the biggest asset are tricky,” says Claire Roberts, tax partner at Moore Kingston Smith, an accountancy firm.
Most people are aware of the seven-year rule — if you gift assets and survive for seven years the gifts will be considered outside your estate for tax purposes.
It is possible to buy IHT insurance to cover any liability if you die sooner, but the older you are, the more expensive this will be. In any case, this will not protect you from the tax complications that can arise from another potential solution — gifting a property you still intend to occupy.
In such cases, families risk falling foul of the Grob rules (a gift with reservation of benefits). “Being able to live inside a gift for free is definitely a benefit,” says Ashford.
To prove otherwise, you will have to pay your children a market rent, but unless you have other assets to draw upon, this could be impossible.
In Pauline’s case, her mother would need to find between £3,000 to £4,000 per month to rent a comparable three-bed house in Brixton. Not only would Pauline and her siblings be liable for income tax on the rental income, they could also face a future capital gains tax liability, as this property is not their main residence.
If your relative needs to go into a care home in future, there is a risk that transferring ownership of the family home could be seen as deliberate deprivation of assets (unless it’s done well in advance). “If they were in good health at the time of making the gift, local authorities would struggle to argue that, but they all differ in how they approach this,” adds Roberts.
Joining forces
Pauline’s idea to buy a more suitable home jointly with her mother would not necessarily be treated as a “Grob” if they were in joint occupation.
“Mum would have to pay her own way for the usage of the property, have her name on bills and be able to provide evidence of paying for her share of household costs,” says Roberts.
Further complications will arise from how the ownership is divided up, and what will happen to her mum’s share in future.
There is a risk that a shared home would have to be sold to satisfy future tax bills or to split an inheritance with other siblings. Relatives providing the most care may be promised (or expect to receive) a greater share of the assets when the time comes. If so, an up-to-date will is required, ideally with an expression of wishes letter. Careful record keeping is also a must.
Alternatively, downsizing to a smaller property or using equity release may offer a simpler solution. This could free up cash to improve older relatives’ quality of life or fund future care costs, plus they could use myriad gifting allowances to run down more of their estate in a measured way.
The complexity of the tax rules and the growing numbers of families who will face IHT bills in years to come mean for many, it’s a choice between paying for expensive advice or making an expensive mistake.
However, tax experts stress that many older people simply don’t want to leave the homes, gardens and communities they have spent most of their lives in. You might see their property as an inheritance tax liability, but to them, it will always be home.
Claer Barrett is the FT’s consumer editor and the author of ‘What They Don’t Teach You About Money’. claer.barrett@ft.com Instagram @Claerb
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