Rent your holiday home for tax purposes

You own a holiday home, worth around £250,000, which you use for several weeks per year. How can you continue to make use of the property but shift it out of your estate for Inheritance Tax purposes?

IHT problem

You think it is pretty likely that eventually your son will take a tax hit on his inheritance from you, including a holiday home that's worth around £250,000. So can you pass the property to your son and still use it as a holiday home?

Lifetime gift. In order to reduce the value of your estate for IHT purposes you can make gifts during your lifetime, which after a period of seven years fall out of the charge to tax. But there is a trap.

Reservation made. In order for the gift to be effective for IHT purposes you (and your spouse) must be excluded from benefiting, other than to a limited extent, from the property being given away. All the time that such a benefit exists the value of the property remains subject to the IHT rules on your death. So you can't give away a property and still live there, or can you?

Renting

Outright gift. The classic solution to this problem is for you to pay a commercial rent for the continued use of the particular asset. Obviously in the case of the family home this often makes the costs prohibitively expensive. There are, however, other assets where the rental cost would be lower than the benefit derived, such as a holiday home.

For example. Even the most modest cottage in Cornwall may have a value of, say, £250,000, which for the couple who own other assets in excess of their nil-rate bands (£650,000 until April 2014) can result in an IHT liability of £100,000 (£250,000 x 40%). If that couple only used the cottage for four weeks of the year, some of which are outside the peak season, then the market rent payable for those weeks may vary from, say, £350 per week in low season to £650 in high season. An annual cost of perhaps £2,000. Based on these figures the couple could rent the property for over 40 years before they paid more rent than the saving in IHT. Good news!

Using a trust

Capital Gains Tax (CGT). If you make an outright gift, there could be CGT to pay on the difference between the current market value and what the property cost you. However, there aren't any sale proceeds with which to pay this bill.

Holdover of CGT. Alternatively, the gift of the property can be made to a discretionary trust. The main advantage of this is that any capital gain otherwise payable on the gift can be deferred until the trustees sell the property. In addition, the rental income received will belong to the trustees and there may be scope for distributing this to non-taxpaying beneficiaries of the trust, able to reclaim all or part of the tax paid on the income by the trust. Meanwhile, you'll be able to keep some control over the asset via the trustees, i.e. the holiday home can't be sold from underneath you.

If you would like any advice on capital gains tax or to talk about this matter with an expert, don't hesitate to contact us on 0191 386 4786