Gary Rycroft Ask a Lawyer

‘Will our granny annexe end up being a tax burden?’

Q

Twelve years ago my parents and my husband and I each sold our respective houses for £ 180,000, and bought a house with an annexe for us all to live in for £360,000.

I am an only child. The new house was put into the joint names of me and my husband.

My parents contribute their share of monthly bills. I am their full-time carer and they do not pay any kind of “rent”.

From their £80,000 savings my parents pay our son’s university accommodation at £2,000 a year and they make frequent cash gifts to us all.

Does the annual £ 3,000 gift limit come into play here, and are we also facing inheritance tax in the future?

– Ruth, via email

Dear Ruth

A

You mention inheritance tax as a concern, so let us look through the lens of HM Revenue & Customs (HMRC) and how it views such arrangements.

The initial house sales and joint purchase resulted in you and your husband being legal owners of the new house and annexe. However, the fact is your parents paid for half. You might say they gifted their half to you and your husband, but HMRC would say that gift was made “with a reservation of benefit”. In other words, your parents reserved for themselves the benefit of having somewhere to live rent-free. This kind of gift is not valid for inheritance tax purposes.

Your parents could have circumvented the “gift with a reservation of benefit” rules by paying a market rent for their occupation of the annexe. Alternatively, if they’d kept their house and moved in with you and your husband, a percentage of the property could have been validly gifted (subject to the seven-year survivorship rule), according to the number of occupiers – as long as household bills and expenses were shared equally between you all.

But in your case the original houses were sold, and the figures are clear, namely you and your husband contributed half to the new house and your parents the other half. Half, therefore, remains in your parents’ estate for inheritance tax.

You mention gifts by your parents to your son and the rest of you. According to the inheritance tax legislation, an individual may gift up to £3,000 a year (twice that in the first year), so your parents may gift £6,000 between them a year. This so-called “annual allowance” puts the capital gifted immediately outside the estate for inheritance tax.

Adding it all up, for inheritance tax purposes your parents own half a house (the current value is not disclosed) and have circa £ 80,000 in savings. To offset the inheritance tax, they will have their own tax-free nilrate band of £325,000 each, which is transferable between spouses, making £650,000 in total. Plus, there’s the residence nil-rate band of £175,000 each, making £350,000 shared. Only if their total estate is over £1m will inheritance tax be an issue.

A point to note is that according to HMRC’s Inheritance Tax Manual in valuing a house on death, shares of less than 100pc may be discounted by, say, 10pc on the basis that owning a share of a property is less desirable than owning the whole, and is therefore less valuable. Unless there has been significant house price inflation in your area and your £ 360,000 house is now worth a great deal more, it seems your parents’ estate will not be liable to inheritance tax.

Therefore, future care needs and fees are the concerns here. Your parents’ capital in the house may be “disregarded” by the local authority if one of them needs care, but maybe not if both do, or if one of them has died when the other needs care.

Inheritance tax rules can be confusing outside the realms of HMRC, not least because “gifts”, which are valid for tax (such as made more than seven years ago) or which are not valid for tax (like your shared house) may have a different interpretation when considering care costs.

For instance, your parents gifting their capital to you and your husband may be valid as a legal transfer of an asset, but HMRC will see it differently. It is a strange concept, but one party may now own something in a legal sense, but HMRC may still tax it as if it were still someone else’s asset.

In the context of your parents needing to pay for care in the future, the gift of capital to you may be valid if it can be shown they did it to ensure they could be provided with care by you, and therefore hopefully stay at home for longer than otherwise. Also, the gift to your son for university may be valid tax-wise, but a local authority may see it as a deliberate deprivation of capital to avoid paying for care.

When doing anything like your parents have done ( giving you capital to buy a shared house) and are doing ( making regular gifts) it is good to record the intention behind the action in writing. If you have not already, you can still do that in a Declaration of Trust.