Despite the increased inheritance tax (IHT) thresholds announced in the March Budget - £275,000 now and £300,000 by 2007 - more families now find themselves within the IHT net. Estimates suggest it could be as many as four million in ten years’ time. The reason is simple! The family home is often the main asset in the estate and increases in the IHT threshold have failed to keep pace with rises in house values. If the threshold had been increased in line with house values since 1997 it would now stand at over £500,000.
As a consequence IHT schemes were developed which were simple in essence but very complex in their execution. They involved removing the family home from the IHT estate, thereby ultimately saving up to 40% of its value in IHT, whilst the former owners continued to live in the property much as they had done before. Seemingly the best of both worlds! This was certainly the Inland Revenue’s view, hence legislation effective from 6 April 2005 which applies an income tax charge in such a scenario. The charge is based on a notional market rent for the property. Assuming a rental yield of 5%, the annual income tax charge for a higher rate taxpayer on a £1 million property would be £20,000. However the upside is that the property is no longer treated as part of the IHT estate and so the eventual IHT saving (after taking into account the £275,000 nil rate band) would be £290,000.
The new rules, referred to as the ‘pre-owned assets’ regime, potentially apply to all arrangements put in place since March 1986 and have been criticised by some for being retrospective.
Although the new regime is a blow for IHT planning it does not by any means sound the death knell. Wills are not affected by the new regime and so it is more important than ever to ensure you have a tax-efficient will. Depending on your circumstances it may be appropriate to consider an equity release scheme or shared occupation of the family home between parent and (adult) child as a means of IHT planning for the future.
The new charge is only applied to those who have entered into certain schemes and arrangements. The options to avoid the charge where it would otherwise apply are:
Please give us a call if you have any questions on pre-owned assets or wish to talk to us about any aspect of IHT planning.