Homeowners are facing an increasingly difficult task in trying to protect their properties from the ravages of the Inland Revenue's inheritance tax (IHT) office. Rocketing house prices have meant the values of many more homes leave owners' estates liable to IHT, even if they have no savings or other assets. The tax is payable at 40 per cent on estates worth more than £255,000, but all assets left between spouses are exempt.
Unfortunately, the options for those seeking a way around IHT have been significantly reduced. Last month the Government closed an important tax loophole which had permitted married couples to set up vehicles called defeasible life interest trusts, which enabled them to protect assets from IHT but allowed them to benefit from their income and capital.
Although the Revenue had tried to challenge this through the courts, it lost a case and failed to have this ruling overturned in the Court of Appeal in May. Last month the Government changed the rules by making a last-minute amendment to the 2003 Finance Bill.
A further measure in the Bill greatly reduces the appeal of home-loan trusts, which have enabled people to place at least the present value of their home outside their estate while continuing to live in it. From now on, properties in these trusts will be subject to stamp duty.
Carolyn Steppler, senior tax manager at the national tax adviser KPMG, says: "It is our understanding that if you undertake this planning before 1 December this year you can at least defer the stamp duty until you sell the property, meaning its costs can be paid from the proceeds of the property sale. But I believe that after this opportunity has gone it will make the cost structure of the home-loan trust no longer attractive. The demise of the home-loan trust means we have lost one of the simplest tax-planning opportunities for the family home."
If you give away an asset and survive for seven years, the asset is considered to be outside your estate for IHT purposes, but you must give up all interest in it. It is no good claiming you have given your home to your children if you continue to live in it, unless you pay a realistic commercial rent.
Stephen Lundy, regional director at the national independent financial adviser (IFA) Berkeley Morgan, says: "It needs to be a commercial rent and you must show it remained a realistic commercial transaction through the whole period. So you must continually review the amount being paid."
Other downsides are that your children will almost certainly have to pay income tax on rent you pay them and, because the home you have gifted them will probably not be their main residence, they are likely to incur capital gains tax on any rise in its value. And your children, after they are the legal owners, could decide they do not want you live in it.
Married couples should also look at a further option, which involves drawing up a discretionary will trust via a solicitor. Most couples own homes as joint tenants, meaning one spouse owns the whole home when the other one dies, but the problem with this is that the entire home will constitute part of the estate on the second death.
Yet, by severing the joint tenancy and substituting it with a tenancy in common, so each spouse owns half the property, up to £255,000 can be passed on tax-free on the first death by using the IHT nil-rate band, which is not used on the first death with a joint tenancy.
By using a discretionary will trust, the deceased spouse's half can be passed to the children but the surviving spouse can continue living in the whole house at the discretion of the trustees.
Clive Scott-Hopkins, director of Towry Law Financial Services, an IFA specialising in estate planning and based in Bracknell, Berkshire, says: "The Revenue is known to be looking disapprovingly at this arrangement, because the survivor is using the whole house but owning only half of it. If the Revenue decides, it may be necessary for the surviving spouse to pay rent to the trust for the half of the property they don't own."
A couple using a tenancy in common can protect a home worth up to £510,000 from IHT by using their separate nil-rate bands, and even more valuable homes can be shielded by unlocking capital via an equity release plan and using this for premiums for a whole-of-life life assurance policy.
It is possible to use both home-reversion equity- release schemes, which enable you to sell all or part of your home but continue to live there as a tenant, and roll-up mortgages, which allow you to retain ownership of your home. The lenders takes back the original sum, plus accumulated interest, on death.
Dean Mirfin, business development director at Key Retirement Solutions, a national IFA specialising in equity release, says: "With a roll-up mortgage, 65-year-olds can unlock 25 per cent of the value of their home and the proportion gets progressively higher with age. The downside is that you are paying interest at 7 per cent and although this compounds up at a fixed rate you cannot work out exactly what the final bill to your estate will be because you don't know how long you will live.
"With reversion schemes, you have defined cost in terms of the percentage of the property you have used. A 65-year-old should be able to raise about a third of the value of the property in exchange for 100 per cent of it."
This week Saga, the over-50s specialist, entered the market with an equity-release mortgage which allows borrowers to take their money in slices, paying interest only on what they have taken. Unlocking capital in this way can reduce the value of your home below the IHT nil rate threshold: writing your whole-of-life policy in trust to your next of kin can keep its proceeds outside your estate.
But selecting the right whole-of-life policy requires professional advice. The most attractive format is provided by Skandia because it guarantees not to raise the premiums during the policy term, allowing you to plan with certainty. For some this option is too expensive.
The cost of a Skandia offer of £100,000 of guaranteed whole-of-life cover, on a joint-life, last-survivor basis, would cost a 70-year-old man and a 65-year-old woman £181.68 a month, assuming they are non-smokers and in good health. Health problems could easily double the premium. Other whole-of-life policies can start off significantly cheaper but can cost more because the premiums are subject to reviews.
Brian Lentz, protection expert at Portfolio Insurance Consultancy, an IFA based in Hatfield, Hertfordshire, says: "The reviewable plans can be a minefield for the uninitiated, because they can bounce all over the place. If you get it wrong there is a danger of not being able to afford to continue at the review stage. The loadings imposed for certain illnesses vary enormously. An IFA specialising in this area will know where to get you the best terms."
TEN WAYS YOU CAN BEAT THE INLAND REVENUE
* Owners of even relatively modest homes can find themselves with an IHT liability;
* The legal options available for avoiding IHT have recently reduced;
* It is worth considering the remaining loopholes while they are still available;
* If you give away your home and continue to live in it you must pay a realistic commercial rent;
* Couples who use a tenancy in common can shield a house worth £510,000 from IHT;
* Married couples should consider a further option, drawing up a discretionary will trust through a solicitor;
* Even more valuable homes can be sheltered from IHT by equity release;
* You can calculate your IHT liability by visiting the website of The Independent associate, Moneynet, at www.moneynet.co.uk
* Go to the Inland Revenue's website, www.inlandrevenue.gov.uk, for leaflets on IHT;
* For a free copy of Saga's Guide to Inheritance Tax, call 0800 300555.
* Berkeley Morgan, call 0161 833 1615;
* Inheritance Tax Planning Group. Visit www.inheritance-tax-planning-group.co.uk;
* Key Retirement Solutions, call 0800 064 7075;
* KPMG, call 020 7311 1000;
* Portfolio Insurance Consultancy, call 01707 262627;
* Towry Law Financial Services, call 01344 828 000;
* IFA Promotion, call 0800 085 3250 or visit www.unbiased.co.uk;
Local tax advisers:
* Chartered Institute Of Taxation, call 020 7235 9381
* Law Society, call 0870 6066 575. or visit www.solicitors-on-line.comReuse content