Our experts take a look at issues arising where parents invest in property whilst a child of the family is at university. Stamp duty land tax, income tax, capital gains tax and inheritance tax are considered for various ownership structures, including trust arrangements.
Alfie and Barbara have recently inherited a substantial sum of money and are considering how to use it; they like the idea of investing in property. They already own their own home in London, a let property in Basingstoke and a holiday home abroad. They are familiar with the responsibilities of landlords and are comfortable complying with statutory obligations and accepting the risks involved. They both work and have a good income between them.
Their eldest daughter Celeste, who is aged 19, is soon to start her second year at Nottingham University; she is on a five year veterinary medicine course and has been looking at accommodation to rent next year. The university provides accommodation on campus for first year students, but after that students are expected to find their own digs. Celeste has got together with a group of three friends and they have been looking for a four bedroom house to rent. Alfie and Barbara were expecting to meet the cost of Celeste’s rent and pay her an allowance to meet living expenses. They were also expecting to have to stand as guarantors for the tenancy of a house.
Alfie and Barbara are considering using most of the inherited money to buy a four bedroom house in Nottingham which Celeste could live in for the next four years. They can see that they could buy something suitable for a group of four students for about £400,000. After that they might sell it, or let it out, depending on how things develop. They are thinking of how they might structure the purchase and the tax implications.
Options for structuring the purchase
- 1) Alfie and Barbara buy the property and rent it to four students
They could use the money to buy the property themselves and rent it for a year to Celeste and her three friends with a view to repeating the exercise next year. Perhaps Celeste will have a different group of friends then, or she might want to live elsewhere in which case they could let it on the open market, probably to students. For the first year they have it in mind for the tenancy to state a market rent, though in practice they would not expect any payment from Celeste, and would just collect rent from the other three. This would be an alternative to them paying Celeste’s rent but they would still pay her an allowance for living costs.
- 2) Alfie and Barbara buy the property and rent it to Celeste
They could use the money to buy the property themselves and rent it for a year to Celeste alone at a concessionary rent. Celeste would live in the property and charge her friends rent as lodgers. This income for Celeste could take the place of all or part of the allowance Alfie and Barbara were going to pay Celeste for living expenses. This would be with a view to repeating the exercise next year; perhaps Celeste will have a different group of friends then, or she might want to live elsewhere in which case Alfie and Barbara could let the property out on the open market, probably to students, or to Celeste at a concessionary rent so Celeste could sublet to a group of students and so generate an income for Celeste. Celeste has no other income, so Alfie and Barbara think this might be tax efficient.
- 3) Alfie and Barbara lend Celeste the money and Celeste buys the house
They could lend Celeste enough money for Celeste to buy the house and cover stamp duty land tax and other costs of purchase. The loan could be secured by a charge back to Alfie and Barbara, but Celeste would be the sole owner. Celeste could live in the house with her friends as lodgers, or if she wanted to she could rent it out. Alfie and Barbara would lend her the money interest free for the first four years as a means of supporting Celeste, so they would not then pay her an allowance or meet any rent as she would have rental income.
- 4) Alfie and Barbara could give Celeste the money and Celeste buys the house
They could give Celeste enough money to buy the house and cover stamp duty land tax and other costs of purchase. Celeste could live in the house with her friends as lodgers, or if she wanted to she could rent it out. Alfie and Barbara would not then need to pay Celeste’s rent or pay her an allowance.
- 5) Alfie and Barbara could set up a trust, put the money into that and the trustees could buy the house
They could set up a trust which could take the money and buy the property. This might be a discretionary trust under which all of their children are beneficiaries with Alfie and Barbara as trustees having the power to give and remove the right to income and/or capital. Initially they might give Celeste the right to income from the property. This would provide Celeste with somewhere to live whilst at university as well as income from her fellow students who would live there. The capital value could in due course be divided between Celeste and her siblings; there would be flexibility under the trust as to how to deal with this, with Alfie and Barbara able to take the decisions.
- 6) Alfie and Barbara could set up a trust, put the money into it and the trustees could lend that money to Celeste so she buys the house
This is the same as option 3 above, but through a trust so Alfie and Barbara, as in the case of option 4, could not recover the money for their own benefit, although they could if necessary recover it to be held on the continuing terms of the trust. The loan would probably be interest-free to keep the trust free from the need for annual tax returns.
- A) Stamp duty land tax
SDLT is now due on slice rates, with each slice of the price paying tax at the relevant rate, with the rates on the higher slices increasing. A purchase for £400,000 is liable to SDLT at different rates depending on the type of purchase:
- £22,000 if the higher rates of SDLT for additional property apply
- £10,000 if standard rates of SDLT apply
- £5,000 if first time buyers’ relief applies.
If Alfie and Barbara buy the property they can expect to pay SDLT at the higher rates. In fact if Alfie and Barbara take any share in the property at all (even if bought “in the name” of Celeste) the higher rates of SDLT will be due on the purchase.
If a trust buys the property then SDLT is likely to be due at the higher rates unless, on the date of the purchase, Celeste has a right under the terms of the trust to all of the income from the property in which case it would be liable at the standard rates.
If Celeste buys the property (options 3, 4 and 6) then on the basis that she does not have any other property interests that “count against” her, she should escape the higher rates and would probably pay the standard rates.
For Celeste to qualify for first time buyers’ relief she would need to meet a number of conditions. It is important that this will be the first interest in a dwelling she has acquired. An acquisition by gift or inheritance could count against her. There is an article about first time buyers’ relief here. Perhaps the most difficult condition for relief to meet is the requirement that Celeste intends to live in the property as her only or main residence. It seems that plans are rather fluid and Celeste might live in it for only one academic year. University terms are surprisingly short and students seem to be away from university for as much of the year as they are there. For many students who have a different room each year and who leave most of their belongings in the parental home, it is the family home which continues to be their base and main residence.
For SDLT, unlike for capital gains tax, there is no ability to elect which of a number of residences is one’s main residence. It is instead a purely factual test. The burden of applying the rules falls on the taxpayer in the first instance as SDLT is a self-assessed tax. There is guidance in the HMRC Manual at SDLTM09812 on how to apply the test and the factors that can indicate which property is the main residence.
Celeste is doing a long course. If she can show a firm intention to base herself in the property for the rest of her course and treat it as her main home then she would have a strong case for saying that she intends to live in the property as her main residence.
It is unlikely that any tenancy set up will be at a rent or for a term sufficient that SDLT will be due on the net present value of the rent, or would even require a return to be filed.
- B) Income Tax
If Alfie and Barbara rent out the property to Celeste and her friends, but only collect three quarters of the rent then they are assessed for income tax on the rent which they actually receive. As they let out another property they will be familiar with what expenses they can deduct. In this case there is no borrowing, so the treatment of interest is not at issue.
If Alfie and Barbara rent out the property to Celeste only at a concessionary rent then they are assessed for income tax on the rent which they actually receive. Celeste should also be able to claim rent-a-room relief in respect of payments made to her by her friends as lodgers, although only up to half of the maximum £7,500 can be claimed because she is not the only person entitled to income from the use of the property in the same period (her parents are getting rent too). Celeste’s personal income tax allowance of £11,850 is likely to absorb the rest of her income free of tax.
If Alfie and Barbara lend Celeste the money interest free for five years Alfie and Barbara are not treated as receiving income. Celeste will be using the money to pay for the house purchase so she will not receive interest from the money.
There are no income tax implications for Alfie and Barbara if they just give Celeste the money and, again, Celeste will be using the money to pay for the house purchase so she will not receive interest from the money.
If trustees buy the property and receive the rent the income tax treatment depends on whether Celeste has a right to the income or only gets it if the trustees exercise their discretion to give it to her. We will assume the trust gives Celeste the right to the income as it arises because the alternative treatment is complicated. The main point is that discretionary income payments are taxed at 45% (although some of that might be recoverable by Celeste), while as of right income payments are taxed at Celeste’s lower personal tax rate of 20% if the income in fact exceeds her personal allowance.
There are also no income tax implications for the trustees if the money is lent by them to Celeste interest-free.
- C) Capital Gains Tax
Capital gains tax (CGT) becomes an issue when the property is sold. The rules might well have changed by then; in fact the 2018 Autumn Budget announced some changes. On the basis of present rules though what could be expected if a gain is made on a sale is as follows.
If the property belongs to Alfie and Barbara then they can each expect to pay CGT on the gain after any unused personal CGT allowance for the year (currently £11,700) at 18% and 28% (18% to the extent that if added to their income it would be taxed at the basic rate).
If the property belongs to Celeste (whether or not she has been lent the money to buy the property) then potentially she could benefit from private residence relief. This depends on the property having been her only or main residence. Similar issues arise as discussed above for SDLT, though for CGT there is the ability to elect.
If the property belongs to a trust when it is sold and has been lived in by Celeste as a beneficiary as her only or main residence then private residence relief is available in the same way; giving Celeste the right to income as it arises ensures that this CGT treatment applies.
- D) Inheritance Tax
If Alfie and Barbara buy the property themselves then any increase in its value will form part of their estate.
If Alfie and Barbara lend Celeste the money so she can buy the property then any increase in the value of the property will be outside their estates, but the value of the debt owed to them by Celeste will remain part of their estates.
If Alfie and Barbara give the money to Celeste direct or they put it into a trust which lends it to her and they do not reserve any benefit from the money then after seven years the value of the gift should fall out of their estates.
If the money goes into a trust it will not be liable for inheritance tax at the lifetime rate (of 20%) if each of Alfie and Barbara can, say, put £200,000 in the trust (and have not made any trust in the previous seven years) because the gift will fall within the £325,000 standard inheritance tax allowance which each of them has that is taxed at 0% (the “nil rate band”).
If Alfie and Barbara were considering making a significant outright gift (to a non-exempt recipient such as a trust) at about the same time they would need to plan the timing carefully – a “potentially exempt transfer” (PET) made after a gift to a trust can lead to extra inheritance tax on the PET if the donor dies within seven years of the PET and the PET was made within seven years of the earlier trust (the so-called 14 year shadow).
The trust will be subject to the “relevant property regime” which may lead to inheritance tax being payable at certain points during the lifetime of the trust, albeit at a rate no higher currently than 6% which is better than the 40% rate likely to apply on the death of the survivor of Alfie and Barbara.
Practical factors are likely to be more important than tax for Alfie and Barbara and include the following:
- Do they really want to invest in a property so far away?
- Would they do better with two smaller properties closer to home?
- Is Celeste mature enough for the responsibilities they propose to put on her?
- What is the danger of the group of friends falling out and the consequences of that?
- Is it appropriate to be making a large gift to Celeste at her age when there are younger siblings? Providing a loan through the trust might enable Alfie and Barbara to maintain control of the money if necessary while at the same time making their estate smaller to save inheritance tax.
- Is a trust appropriate at this stage of their life and what other gifts might they make in the future?
- A trust can impose compliance duties on the trustees, such as tax returns, which Alfie and Barbara might not want.
Originally posted by John Shallcross on 26 March 2019.
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