The Cost of Poor Tax Advice
We were contacted recently by potential clients with an interesting situation. They wanted to review their likely inheritance tax position. In 2003 they had asked a solicitor to put their home into a trust in order to avoid possible care home fees.As there was no capital gains tax incurred on their home and the value of the property was below the nil rate band allowance there was no tax to pay. Unfortunately by doing this they had unwittingly created a significant problem which we were unable to help them with.
Trusts & Inheritnace Tax Planning
The reason Trusts are so effective for Inheritance Tax Planning is because they work on the basis that the Trust is recognised as a separate legal entity under English Law.In this particular case the property has virtually doubled in value in the last 15 years. The Trust now fully owns the property and any disposal of it in the future either by gifting it back to the client or to their children will generate a capital gains tax bill of around £80,000.
Residential Nil Rate Band
The situation is compounded by the fact that the house is entirely owned by the Trust, meaning the clients lose their allowance for the Residential Nil Rate Band (RNRB). This will be £175,000 each by 2021.
The RNRB allowance is only available to individuals gifting their main residence to direct descendants or adopted children and therefore not available to a Trust.
Gift with reservation of benefit
To further exacerbate the problem the clients have not been paying any rent to live in this property they gifted to a Trust. As such, HMRC will regard this as a “gift with reservation of benefit”. Therefore the value of the property (but not the legal ownership) which is around £650,000 will fall back into the estate. Consequently the £650,000 is now liable to Inheritance Tax even though the actual legal ownership of the property no longer resides with the potential clients.
The clients have other assets of around £400,000. This gives them a potential IHT liability of £160,000. If they do nothing about this it will increase depending on the value of the property (which is a failed gift) and the value of their other assets.
So to recap, the intention behind the initial planning was the potential avoidance of care home fees. However, it is likely that the local authority will stipulate that the right to utilise and remain in the property still resides with the client. They are likely to insist that the property is rented out and that income utilised for care home fees. So even the original idea will not work.
The cost of the wrong decision
These potential clients didn’t take advice from an Independent Financial Advisor before they embarked upon moving their house into a Trust. They merely instructed a solicitor to act on their behalf for the conveyancing. They will end up at the very least paying a large CGT in the Trust, and if they do nothing they will end up with a much larger IHT bill on their Estate. Ironically if they had done absolutely nothing they would not have paid anything in tax provided one of them survives until 2021 which is highly likely. We couldn’t help these potential clients because the Trust was already in place, so we referred then back to their original solicitors.
The moral of the story is that lack of good advice has cost the inheritors of these potential clients over £80,000 in unnecessary tax.
To avoid situations like this it is vital to take experienced advice before progressing with any plans that you believe will have a direct impact on your taxation and IHT. Contact us now for reliable and expert inheritance tax advice.