With rising house prices and tighter lending criteria, it is increasingly difficult for young people to get onto the housing ladder. In most cases, they will need to call on the Bank of Mum and Dad.
Parents who want to help their children are often uncertain about the best way to provide the funds, the tax consequences and the legal position of boyfriends, girlfriends, sons-in-law and daughters-in-law. Many parents are concerned about what would happen to the funds if their children were to divorce, for example, or if the funds were used unwisely.
So what is the safest and most efficient way for parents to help?
An outright gift of cash for a deposit is straightforward and relatively tax-efficient. Provided that the parent making the gift survives seven years, it will be outside of their estate for inheritance tax (IHT) purposes when they die. IHT is otherwise charged at 40 per cent on the value of the estate above £325,000.
An outright gift won’t protect this family money, however, if the young couple were to get divorced or go bankrupt.
An alternative approach would be to buy a property for a child to occupy. This arrangement provides asset protection but is not tax efficient.
When the property is sold (assuming it has gone up in value) any gain will be subject to Capital Gains Tax (CGT) because, for tax purposes, it will be treated as a second property. For the same reason, the property will end up costing you more overall, once the stamp duty surcharge on second homes (3 per cent above the standard rate) has been applied.
Because there is no gift, the value of the property as it increases will remain within the parent’s estate for IHT purposes.
The value of an extra property could push you above the IHT threshold, which means that your estate will face more tax. If there is insufficient liquid cash in the estate to pay the IHT due, the personal representatives who administer it when you die might be forced to sell or mortgage the property to raise the necessary funds to pay the IHT.
There is a middle ground. Parents could lend the funds, ideally securing the money against the property by placing a charge on the Land Registry title in the same way that a commercial lender would.
Usually, a family loan will be interest free. This approach offers asset protection and tax efficiency for CGT and stamp duty but not for IHT, as the value of the loan will remain in the parents’ estates.
An approach which can combine the best of both worlds – the asset protection of a loan with the tax efficiency of a gift – is for parents to gift cash to a trust. The trustees can then lend the money to the children.
A gift to trust can be more tax efficient than an outright gift as not only will the funds not form part of the parents’ estates after seven years, but they will also not form part of the child’s estate.
We recently acted for a couple whose daughter was looking to buy a property with her boyfriend. Both were in their early 20s and had saved a small deposit between them. However, they were struggling to find a mortgage large enough to purchase a property of the size they wanted.
The daughter’s parents were happy to provide £325,000 towards the purchase, but were conscious that their daughter’s relationship with her boyfriend was still at a relatively early stage. They were also open to ways to reduce the size of their combined estate from IHT.
Rather than gift the funds to their daughter outright or lend funds to her directly, the parents gave the cash to a lifetime trust of which the parents were the trustees. From there the funds were lent to the daughter interest-free to allow her to buy the property. The trustees took a second charge over the property to secure the loan.
The gift to trust was made by the mother in this case as the mother was statistically more likely to survive seven years. So long as she does indeed survive seven years from the date of the gift, the funds will not form part of the parents’ combined estates for IHT, nor the daughter’s, which could save up to £130,000. The trust can exist for up to 125 years and so the funds can potentially be used for future generations of the family as well without being subject to IHT.
Trusts of this nature are subject to IHT charges every 10 years, but so long as the value of the loan is less than the IHT nil rate band threshold at the time, there will be no IHT to pay.
The trust structure is also tax efficient for buying and selling the property. As the house was purchased in the names of the daughter and her boyfriend, the stamp duty surcharge for second properties did not apply.
If the daughter and her boyfriend wish to move in the future, the sale will be free of CGT in the normal way for a principal private residence. The funds will be repaid to the trust and the charge removed at that point. If the parents (in their capacity as trustees) agree, the funds can be lent again on agreed terms to help fund the purchase of a different property.
It is crucial to discuss all this at the start, so the parents, the child and their partner can all agree to the terms.
The daughter and boyfriend were encouraged to draw up a Declaration of Trust between them to set out their beneficial ownership of the equity. The daughter’s share of equity was larger to reflect the loan made to her from trust. It also set out how the property would be divided if they split up, including provision for each party to have the option to buy out the equitable share of the other.
Regardless of how the funds are provided, where the property is to be co-owned by a partner or spouse it is important to put in place a Declaration of Trust to ensure the division of the equity of the property, including any provision from parents, is clearly documented at the start.
Similarly, if a child purchases a property in their sole name but occupies with a partner or spouse, a formal waiver of any rights created by virtue of their occupation may be appropriate.
In every case it is best to consider the rights of all involved as early as possible to avoid acrimony in future.