With the combination of high house prices, the high cost of living and increasing levels of student debt, parents, grandparents and other relatives are now donating more and more towards the cost of the fledgling’s first home with the average donation well in excess of £20,000, if not higher.
Most who feel obliged to help in this way will see their savings as the first point of call. So what are the tax implications and are there any other ways for a parent (or other) to help fund a first home?
The simplest method of contributing to your child’s home is to provide capital for them as a deposit. This straightforward, no-strings-attached gift of cash would be Capital Gain Tax free and Income Tax free but a “Potentially Exempt Transfer” for Inheritance Tax (survive seven years and the value falls outside of your estate). Whilst for most people, that would be the end of it but in certain circumstances were you to move in with your child (say in old age), you may become subject to the “Previously Owned Asset Tax” (POAT) which is a charge on an individual who has made a gift but in later life attains some benefit from the initial present – in this case the money you gifted forming part of the value of the house in which you now reside.
Another approach is to make a loan to your child. Any such loan could be either interest-bearing or interest-free as you see fit, and either secured or unsecured (although making a secured loan against a property against which there is also a commercial mortgage can be problematic as most banks will want the first charge over the property). Any interest that you do charge must be consistent (and ideally this should be put down in a formula in a document for both parties to keep) and you should remember to declare any gross interest on your annual tax return. As you have not gifted the funds, the value of the loan outstanding as at your death will form part of your estate for IHT purposes. The loan choice does allow capital growth in the property to be in your child’s hands rather than in your estate, whilst still allowing an element of interest and control if desired. In recent years, some banks have spotted this niche area and now offer specialist mortgages which use your savings to either guarantee the mortgage or be used as an off-set against the capital borrowed (thereby reducing the interest payable). Typically these products could involve your savings either earning little or no interest or be tied up for a set period or until the value of the mortgage reaches a certain point and specialist independent mortgage advice should be taken if considering these products.
A third option could be to purchase a property for your child – with a mortgage if necessary. This choice is often used where university education is involved and the house purchase allows good accommodation whilst still studying as well as capital growth for you in the housing market. Spare rooms could be let to help defray costs but rental income is taxable and would need to be declared on your annual tax return. When you dispose of the property, you would be subject to Capital Gains Tax and of course the property would also form part of your estate for IHT purposes as appropriate. (A halfway measure of course is part ownership of the house by you with the remainder being owned by your child. When the property is sold, an element of principal private residence exemption should still be available – on your child’s half – whilst still allowing you an element of control over the property purchased).
A variation on this idea is the use of a Trust to own the property (although obtaining finance is often harder where a Trust is involved). The use of the Trust has the dual benefits of removing funds from your estate and at the same time protecting the property against divorce and financial immaturity as your child does not own the property itself, merely having a right or potential right to occupy the property under the terms of the Trust deed. There can be, however, additional tax implications for the use of a Trust which ought to be viewed as the “price” for such flexibility and protection.
There are further tax implications if at a later stage you decide to write off a loan that you have made or to gift a property that you own. As a result, you should take time to consider the “what-if” scenarios and try to cover them in any loan agreement or other paperwork. For example, what would happen to money that you gift as a deposit were your child to divorce – do you need to add some protection against that? What would happen in the case of a loan to your child should you die? As usual, professional advice can be invaluable for this sort of planning.
Whichever way you choose, care should be taken to ensure that you know the implications (for good and bad) for all parties when you help your children fly the nest.
For more information on the above tax implications please speak to your usual Ensors contact, send us a quick enquiry or email Danny Clifford, Tax and Trusts partner.