The Bank of Mum and Dad

September 18th, 2009

The average house price currently stands at £153,046, having reduced by 14% over the last 12 months (source: Land Registry 28th July 2009).  This reduction may encourage first-time buyers back into the market and according to research conducted by the Council of Mortgage Lenders, 80% of first-time buyers aged under 30 are thought to be receiving assistance from their parents to find the current required deposit of up to 25% (source: CML 21st July 2009).

There are a number of ways parents can help their children on to the property ladder, however, this article only considers the main ways for parents to pass money to their children – as a gift, a loan, or as an investment.  Either of these can seem to be a straightforward arrangement, but there are a number of pitfalls to avoid that may not be initially obvious.

Outright Gift

Where the money is given as a gift, there are potential Inheritance Tax implications.  Everyone has an annual gift exemption of up to £3,000 each tax year, but because any part of the exemption, which has not been used in the previous tax year can be carried forward to the next tax year, it may be possible that up to £6,000 could be given tax-free as an outright gift in the current tax year.

If the gift is a wedding present then each parent can gift up to £5,000 to their child and this will be exempt from Inheritance Tax.  If the annual exemption has not already been used then each parent could gift up to £8,000 (or £11,000 if two annual exemptions are available) to their child exempt from Inheritance Tax.

Other available exemptions include small gifts and gifts that are part of your normal expenditure.

The value of a gift over the exempt amount is known as a ‘potentially exempt transfer’. If you live for 7 years after making the gift then it will be exempt from Inheritance Tax.   If you die within 7 years of making an outright gift and the total value of all the gifts you have made in the 7 years before death is less than the Inheritance Tax threshold (£325,000 in 2009/10), this will have the effect of reducing the nil-rate band available on death to offset against the value of the estate.

If you die within 7 years of making an outright gift and the value of the gift, when aggregated with any other ‘chargeable transfers’ made in the 7 years before the gift in question, is more than the threshold Inheritance Tax will be due on the gift.  In this situation, Inheritance Tax may need to be paid by the person who received the gift.  If you die between 3 and 7 years after making the gift, and the total value of gifts you have made is over the threshold, any Inheritance Tax due on the gift is reduced on a sliding scale.  This is known as ‘Taper Relief’.

Apart from the potential tax implications, it is also important to consider that you may not be able to ensure the money gifted is used for the purpose it is intended – a deposit on a house.  Once the money is gifted, it belongs to the recipient and they may subsequently decide to use it for another purpose.

A further possibility is that shortly after gifting the money your child dies.  If this is before the house purchase proceeds and he or she has made a will it is likely that the money will go to their named beneficiaries, which may not be you. Even if they have not made a will, under intestacy rules you may also not have the money returned to you.  If the house purchase has completed then ownership of the house could pass automatically outside their estate to their spouse/partner, if ownership of the property is on a joint tenancy basis with the other person.  This may not be an issue for you, although it can be if you do not get on with the other person.

A Loan

Where the money is being lent to your child it is important that a formal legal document is drawn up to avoid any confusion should circumstances change.  Potential problems can occur if, following the making of the loan, you die and your surviving spouse needs the money repaid in order to live on, or to pass to your other children in order to meet the terms of your will.  Problems could also occur if the marriage or relationship of your child breaks down. The document should therefore include details about the basis on which the loan has been made, what will happen to the money if one of the parties dies, or your child and their spouse/partner split up, or if you need the money back.

The situation can appear simpler if you are lending to a child who is single however, it is still important to get a formal document drafted as circumstances can change and people do fall out.

If interest is charged on the loan and the value of the property increases, there could be a potential Capital Gains Tax liability.

An Investment

If you decide to assist by investing in your child’s property this will also have potential tax implications.  There could be a potential Capital Gains Tax liability if, when the house is sold, there is a profit.  Should you die, your share of the house will be included as an asset in your estate, with a potential Inheritance Tax liability.

In summary, although passing money to your child may seem straightforward the methods of doing this are fraught with potential pitfalls.  It is important that you think through all the potential scenarios, ensure that written agreements are in place where appropriate and take legal and financial advice to ensure problems do not occur in the future.

The levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.