Hands off our houses

A House of Lords ruling could enable families to avoid inheritance tax when passing homes to their children. But will this `window of opportunity' last? Paul Slade reports
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Hundreds of British families could escape paying inheritance tax when passing homes on to their children, thanks to a House of Lords ruling earlier this month. The Lords ruled that Lady Ingram, who died in 1989, was entitled to reduce the tax due from her estate. She did this by giving the freehold of her home, Hurst Lodge in Berkshire, to a family trust, but retaining the leasehold and continuing to live there rent- free.

Until now, the Inland Revenue has barred this practice by treating such transfers as gifts with reservation of benefit, which could be ignored when the giver dies. If the gift was ignored, its value was treated as never having left the estate, and hence was subject to inheritance tax.

David Norman, principal consultant at KPMG Personal Financial Services, says: "What we seem to have now is confirmation that it is possible to do what Lady Ingram did, and that the gifts with reservation rules have limited application.

"How long that continues to be the case is another issue, because it is possible that the Revenue, smarting from this decision, will want to change the rules as soon as possible."

A Revenue spokesman confirms that they are already considering how costly the loophole opened by the Ingram ruling is likely to be: "We'll study the terms of this judgement carefully, and then we'll consider the implications for the inheritance tax rules. Ministers will then decide whether to make changes in the law".

Even if the Revenue does crack down, Norman thinks they are unlikely to do so retrospectively. This creates what he calls a "window of opportunity" between now and whenever the crackdown may come.

Inheritance tax starts to bite on estates worth over pounds 223,000 - not that huge a sum when you remember that it includes the value of your home. Genuine gifts made seven years or more before you die are exempt from the tax.

In Lady Ingram's case, the crucial part of the deal was the separation of freehold and leasehold title on the property. She gave away the freehold to a family trust in March 1987, but took in return a rent-free lease allowing her to continue living there.

When she died, aged 74, in February 1989, the Revenue argued that the 1987 transfer should be ignored as a gift with reservation. They said the inheritance tax due from her estate should be calculated on the 1989 value, instead of the far lower 1987 value, which the estate argued should be used. The estate won.

In his 10 December judgement, Lord Hoffman said: "It is clear that the scope for discrimination in limiting the terms of the gift to exclude interests which the donor wishes to retain is very wide.

"In particular, the beneficial ownership of land may be divided in terms of time as well as space, so that the right of enjoyment of the land for a limited period and the right to enjoy the land after the expiry of that period can exist simultaneously. One interest may form the subject matter of a gift, while the other is retained".

On the face of it, the case would seem to suggest that, had Lady Ingram lived the full seven years after making her gift, the value of her home could have escaped inheritance tax altogether.

David Marcus, a partner at solicitors Jay Benning & Peltz, says that separating out the leasehold of a property when you own the freehold presents no problems in itself.

"If you own the freehold of a house, then - subject to planning and safety and things like that - you can almost do what you like," he says. "If you own the freehold, then you can grant whatever kind of lease you want to."

But this tactic is only open to those who have already cleared the mortgage. Your lender is likely to take a dim view of such moves if they still hold a stake in your house.

Sue Anderson of the Council of Mortgage Lenders says: "They would no longer be lending on the same basis. They wouldn't necessarily have control of who ended up with the freehold interest in the property, and that could create all sorts of problems from a lending point of view."

Many people will however waste no time in following Lady Ingram's example, David Norman believes.

He says: "There are some people who have been waiting for this decision, and who will now go ahead. We're talking about people who have difficulty reducing their inheritance tax by straightforward gifts of cash or shares, simply because they need those assets to live on. Really, the only asset of any size which they could do something with is the house."

But there are dangers, as Norman points out: "The problem with inheritance- tax planning is that you gift assets away to your children. There's the risk that they make bad marriages and, after the divorce settlement, suddenly half the money has gone. For many, the tax is a small price to pay for the peace of mind of continuing to own their home."

Although it was not part of the Ingram case, it seems quite likely that families could use the same methods to protect property assets from being sold to pay for care when older people go into residential homes. Older people may well be able to give away the freehold to their heirs, and retain a lease giving them the right to continue living at home. When they move into care only the leasehold value could be considered as part of their estate which local authorities have the right to claim to help pay for the costs of long-term care. But this may have to be tested separately in court.