Mark McLaughlin looks at some inheritance tax points to consider for parents wishing to help adult offspring manage their mortgage debts.
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These are difficult times for most young people buying their first home, or for recent first-time buyers trying to keep up with their mortgage payments. Some offspring will need help from their parents to get (or stay) on the property ladder.
Cash lump sum
With some thought and planning, it can be possible for parents to help adult offspring in an inheritance tax (IHT) efficient manner.
The most obvious way would be to give the children a lump sum to pay off all or part of the mortgage. A cash gift is a potentially exempt transfer (PET) for IHT purposes, which becomes exempt if the parent donor survives at least seven years.
Funding mortgage repayments
However, there are other possible ways for parents to help, which do not involve a seven-year waiting period for IHT purposes. These include taking advantage of the IHT exemption for ‘normal expenditure out of income’.
An individual can benefit from this exemption to the extent that certain conditions are satisfied, i.e., broadly:
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the gift was part of the normal expenditure of the donor;
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it was made out of their income (taking one year with another); and
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the donor was left with sufficient income to maintain their usual standard of living.
For example, if the parents wished to make regular transfers of funds to help their offspring with mortgage payments, the IHT exemption may apply if the gifts satisfy the above conditions. There is then an immediate reduction in the donor’s estate; the seven-year waiting period does not apply (although HMRC might seek to establish whether the exemption conditions were satisfied if the donor dies within seven years and IHT is at stake).
Loans instead of gifts
Alternatively, the parents could (for example) make an interest-free loan to enable the children to buy their home, instead of making an outright cash gift. Whilst the loan remains part of the parents’ estates, the interest-free element of the loan should not constitute a PET, provided the loan is repayable on demand.
If the parents later decide to convert the loan into a gift, care is needed to ensure that the loan release is effective in law (NB this article only focuses on English law). For example, if the release is made voluntarily and without consideration, it must be made by deed (Pinnel’s Case [1602] 5 Co. Rep 117a); this might be a signed agreement specifying that it is intended to be a deed. Otherwise, the debt remains an asset of the parents’ estate for IHT purposes.
Accepting a lesser amount in repayment of the debt will not generally be effective either. However, there are certain exceptions, such as for early repayment at the parents’ acceptance Foakes v Beer [1884] UKHL1), or the acceptance of repayment in non-monetary form (e.g., the creditor “might take a horse, a canary, or a tomtit if he chose”; Couldery v Bartrum (1881) 19 Ch D 394).
If the parents’ debt release is effective, there will still be a PET to the extent that their estates are reduced as a result.
Practical tip
Problems could arise if the parents later borrow back money they have gifted, due to anti-avoidance rules (FA 1986, s 103). Specialist professional advice should be sought, if necessary.
