INHERITANCE TAX – PLANNING
Synopsis: A reminder of the rules on valuation of undivided shares in joint property and how these can be used to obtain a planning advantage in certain circumstances.
Date posted: Thursday, December 12, 2013
Where two people own a property jointly, they will own the property either as joint tenants or as tenants in common. The main difference between these two forms of co-ownership is that while property owned as beneficial joint tenants will pass automatically to the survivor on the death of one of the joint owners; tenants in common own a specific identifiable share of the property that can be passed to a third party under the terms of their will.
Regardless of how the property is owned (and how it will be treated for succession purposes), the deceased’s share of jointly owned property will form part of the deceased’s estate for inheritance tax (IHT) purposes (although an exemption will, of course, apply where the deceased’s share passes to their spouse/civil partner). It will therefore be important to understand how a share of jointly owned property is valued on death of one of the joint owners – particularly if the property is left to someone other than a spouse/civil partner as this will determine the amount of IHT payable on first death and the amount of transferable nil rate band available to the survivor (if relevant).
HMRC practice in this regard is to discount the value of a deceased person’s share in jointly owned property to reflect:
- the difficulty in selling a jointly owned share of a property
- the fact that the value of a joint owner’s share may be reduced because the other owner has the right to keep living in the property
The reduction will depend on the size of the share that the person holds and who the other owner is but will usually be in the region of 10-15%.
Basic principles
As stated above, whether or not a discount will be available and what amount of discount will be given, will vary according to the specific circumstances of the situation. The following broad principles apply:
1. Half share, joint owner occupiers
Where the surviving co-owner occupies the property as their main residence, the normal approach is to take half the freehold vacant possession value and deduct 15% from the deceased’s half share.
2. Half share, joint owner not in occupation
Where the surviving co-owner has a right to occupy the property as their main residence, but, by choice, did not actually occupy, it is necessary to consider the purpose behind the trust for sale or trust of land. If this purpose still exists and is capable of being fulfilled the discount would normally be 15%. In other cases the discount will be limited to 10%.
Example:
Mr and Mrs Adams bought a house for their joint occupation. When Mr Adams died he left his one-half share to his son Ben who lives elsewhere. Mrs Adams has now died and it is therefore necessary to value her one half-share.
As Ben is not in occupation at the date of his mother’s death (and the house was not purchased for his occupation), Mrs Adams’ one-half share will be discounted by 10%.
By contrast, if Ben had died before his mother then, at the date of Ben’s death, the other co-owner, Mrs Adams, would still have been in occupation and the purpose behind the trust would still have existed (because the house was purchased for her occupation). Ben’s one-half share would therefore be discounted by 15%.
3. Shares other than half shares
Where the deceased co-owner had a minority share in the property (rather than a one-half share), then a discount in excess of 10% may be appropriate. However, it is envisaged that the amount of such a discount will only exceed 20% in very exceptional circumstances (Charkham v CIR [1997]). While a majority shareholder is normally in a more powerful position than a minority one, the ownership of such a share still has its disadvantages and a discount of up to 10% will be applied in normal circumstances.
4. Husbands and wives
Special provisions apply to the valuation of an undivided share where another share is held by the transferor’s spouse, or civil partner.
The rule (contained in section 161 IHTA 1984) is briefly, that where the value of any property comprised in a person’s estate would ordinarily be less than the appropriate portion of the aggregate value of that property and any related property, the value shall be the appropriate portion of that aggregate. In other words, if the property is worth £1,500,000 and a half share would ordinarily be valued at £637,500 (i.e. to reflect the aforementioned factors), if the half shares are in fact related property, no discount will apply and the half share will instead be valued at £750,000 (i.e. a straight half of the aggregate amount of £1,500,000). Subsection (2)(a) of section 161 provides that property is related to property comprised in a person’s estate if it is comprised in the estate of his spouse or civil partner.
Practical application
Having reminded ourselves of the basic rules, we can now consider how clients may be able to use them to their advantage in estate planning. Take the situation where husband and wife own a property jointly, sever the joint tenancy and leave their respective tenant in common shares to e.g. son or daughter under the terms of their will. On first death, no discount will be available in valuing the share that passes to the child as a result of the related property rules. However, on second death, not only will the deceased’s share (and the growth thereon) be outside the estate of the surviving spouse, the share remaining in the ownership of the survivor will be discounted by up to 15%. Where property values are significant, this can lead to substantial IHT savings.
Lifetime gifts
A gift made during lifetime will not be effective in securing a discount on the later death of the donor if it is a gift with reservation. A reservation will usually exist where the donor continues to benefit from the gifted property in some way.
However, the gift with reservation rules do not apply to gifts of undivided shares of land where:
- The donor does not occupy the land;
- The donor occupies the land to the exclusion of the donee for full consideration; or
- The donor and the done share occupation and the donor does not derive any benefit (other than a negligible one) from the gift
If one of these exceptions applies, there will be a fully effective PET. This means that even if the donor does not survive the subsequent seven year period, an immediate reduction in the estate will be obtained by virtue of the fact that the value of the retained share will be diminished as a result of the co-ownership.
Example:
Barbara inherited Bluebell Cottage on her husband’s death six years ago. She decides to gift a share of the property to her daughter Elizabeth who has never married and has moved back home to give Barbara a bit of help around the house. As both Barbara and Elizabeth pay their fair share of the outgoings, the exemption in S102B(4) applies and there are no gift with reservation issues.
On Barbara’s death, four years later, Bluebell Cottage is valued at £780,000. Barbara’s share is £365,000 less a discount of 15% i.e. £310,250. This means that even though Barbara didn’t survive the seven year PET period, she has obtained a £54,570 reduction in her estate.
Non-tax reasons to sever a joint tenancy
Severing a joint tenancy can have other advantages too. As clients live longer, there is an increased possibility of them needing residential care. Clients will naturally want to preserve wealth in these circumstances by ring-fencing assets. The problem is that where assets are gifted or converted into assets that are disregarded from the means test calculation, the deliberate deprivation rules will apply to treat the resident as having notional capital equivalent to the value given away.
Where steps are taken to ensure that residential property is held on a tenancy in common so that on death of the first of the joint owners to die his or her share can pass to a third party (or to a trust); only the half share that is owned by the survivor will be taken into account for the purposes of any means test assessment should he or he subsequently need residential care. Furthermore, the value of the share on the open market is likely to be negligible in view of the existence of a co-owner with rights of occupation. As no gift has been made by the surviving client, this strategy does not count as deliberate deprivation despite its effectiveness in ring-fencing the home.