Page last updated at 13:14 GMT, Thursday, 5 April 2007 14:14 UK

Ask the expert: Inheriting property

Simon Rees of PricewaterhouseCoopers
This week's expert: Simon Rees

BBC News' Ask the Expert column gives readers a chance to have their financial questions answered.

This week, Simon Rees, senior manager in the private client practice at accountancy firm PricewaterhouseCoopers, helps Your Money reader Alex.

In 1996 Alex's parents gifted their house, then worth about 150,000, to him and his sister.

His parents were told that the gift would be tax-free, as long as at least one of them survived during the following seven years.

Earlier, in 1991, the parents had made separate wills leaving their halves of the property to Alex and his sister when they died, on the condition that the remaining surviving parent lived in the house.

On the eventual death of the remaining spouse, the remaining half of the property would also then go to Alex and his sister.

Recently his father died and this has caused Alex to ask some important tax questions.

The house has now risen in value to about 400,000, and their mother is living in the house rent-free.

Alex is concerned that they are now in a "big tax hole" - and he wants to know if the original arrangements can be undone.

Simon Rees writes:

This is a classic example of tax planning gone awry.

The scheme you came up with, because it wasn't thought through fully, actually just made things worse than if you had left it alone. It really shows how easy it is to get into an enormous muddle.

With escalating house prices, more people will be thinking about this very problem - how to shelter their house from a huge Inheritance Tax (IHT) bill - but the warning is, and you would expect me to say this, you really need to take serious professional advice.

Your parents had spotted the IHT problem building up and, like so many others, wanted to do something about it without being forced to leave their homes.

It's a common problem, made worse by ever increasing property values.

The recent Budget attacked some quite sophisticated tax planning schemes, which sought to address exactly this issue.

The planning your parents did was, unfortunately, not in that league of sophistication.

I am not sure if they took professional advice, but if so, my first inclination would be for you to suggest to anyone who had advised at the time, that they now have some obligation to help to sort things out.

DO YOU HAVE A QUESTION?

As you have discovered, it is not too easy to have your cake and eat it.

The "inheritance gift with reservation" rules operate so that if you simply give away an asset, but continue to have the benefit of using it, the gift is simply ineffective for IHT purposes.

The result in this case may be worse than if you had done nothing.

When doing any tax planning, it is essential to consider all the taxes which might bite.

No exemption

In this case, the original theory attempted to deal with the IHT issue, without giving much thought to the capital gains tax (CGT) side.

As a consequence of the gift, even if it had worked for IHT, your parents no longer owned their own home for the purposes of CGT.

You will be aware that your parents would normally be exempt from CGT on the disposal of their own home.

However, because they have given the house away the actual owners (you and your sister) do not qualify for that exemption because you do not live in this home and therefore it does not qualify for the "Principal Private Residence Exemption" (PPR).

Also, because the house is no longer your parents' it won't be part of their estate and thus, for CGT purposes, won't pass across to their beneficiaries at its uplifted value at death.

Normally when you inherit an asset, your cost for CGT purposes will be based on the value of the house at death.

In your case both the PPR exemption and the uplift won't apply.

I think that not all hope is lost
Simon Rees
This leads me to question the wills you mention. The wills were made in 1991, but the gifts of the property were made in 1996.

When your father died, then, the house was no longer his to give. At the time of his death, he simply didn't own the house. The clauses in the wills are irrelevant.

The key is to look at the documentation around the gifts. Is there any?

It is possible that your father's gift fell within his estate at death, because it might simply have been treated as a "gift with reservation" i.e. one that didn't work for tax.

In this circumstance it could be covered by his own IHT exemption, currently 300,000 (2007/2008 tax year).

If that is the case, the amount that will fall within your mother's estate when she dies would be much reduced, and again may be within the IHT exemption.

This still leaves you with the CGT problem, but that is longer-term, with the timing within your control.

Update plans

Careful planning (not least for you and your sister to consider splitting your shares of the house with your respective spouses, maximising the allowances and lower tax rate bands), plus the benefit of "taper relief", may enable you to reduce that bill significantly.

In short, I think that not all hope is lost, but some very careful examination of the facts is needed.

The key message is to look at taxes as a whole and not just focus on one.

If you are going to get into tax planning it is important to take advice and update your planning as and when your circumstances change.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.


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