A major problem facing our younger generation today is getting their foot on the property ladder. Recent statistics show that 48% of 20 to 34 year olds are living with their parents because they cannot afford to buy their own home. With house prices through the roof and lenders reluctant to loan any more than four times your single or combined income, how can our children raise the funds to put down a deposit on their first home.
You may have thought about gifting or loaning your children money to purchase property. But how would this money be treated for Inheritance Tax (IHT) purposes depending on whether it is a gift or a loan?
Jeremy (64) and Margaret (61) own two properties with a combined value of over £1million, they also have surplus capital in savings of £400,000. Margaret and Jeremy have mirror Wills leaving everything to one another and then to their only child, Sam (23). Sam, is thinking of buying his first home and Margaret and Jeremy would like to help him. For IHT purposes they don’t know whether it would be best to loan the money to Sam or gift it to him. Jeremy and Margaret GIVE Sam £100,000
For IHT purposes, if Jeremy and Margaret give the money to Sam, the gift would be treated as a PET (Potentially Exempt Transfer). PETs are not chargeable to IHT unless the donor of the PET dies within seven years of making said gift. As the gift is a joint gift from both Jeremy and Margaret, the gift is treated for IHT purposes as if each have gifted £50,000.
Should one or both of them die in the following seven years, the gift of £50,000 would be aggregated back into the Deceased’s estate when calculating whether or not IHT is chargeable or if any of the Deceased’s Nil Rate Band (NRB) has been utilised. First and foremost, the Deceased’s NRB is reduced by any failed PET. If either Jeremy or Margaret had given away more than their Nil Rate Band during their lifetime then tax may be payable on the gift and unless there is an express provision in the Will to the contrary, this tax must be paid by the Donee of the gift.
In the circumstances, however, neither Jeremy or Margaret have made additional gifts in the seven years prior to their death. Therefore, on their passing within seven years of the gift, their respective NRB’s will be reduced by £50,000 and the gift itself does not fall to be taxable. Jeremy and Margaret LOAN Sam £100,000
Jeremy and Margaret loan £100,000 to Sam from their capital savings, reducing their estate worth to £1.3million. Sam agrees with his parents to pay the loan back within in three years with interest of 1%.
Again for IHT purposes, this would be treated as a joint loan and as if £50,000 had been loaned from each Jeremy and Margaret’s estate. Upon either Jeremy or Margaret’s death the debt is considered to be an asset of each estate. On the first death, the £50,000 debt would pass to the surviving spouse. However, on the second death IHT would be payable on the debt as an asset because their combined estate exceeds the Nil Rate Band. The excess over and above the NRB will be liable to tax at 40%. In the event that part of the loan has been repaid, only the outstanding debt will be re-aggregated with the estate.
If the loan given to Sam was interest free and made without any evidence, HMRC will likely view the loan as a gift. This therefore takes us back to considering PETs and the seven year rule.
It is always advisable to evidence any type of loan in a legal document, even if it is between family members. If your preference is to gift, and you wish to shift the burden of who pays the IHT, it is important to take professional advice and consider reviewing your Will to take account of the gift. If you would like an Inheritance Tax consultation as part of our Will drafting service, please get in touch with a member of our team.
For more information, please contact a member of our Wills and Probate Team on 01279 755777.