Property Tax Planning:
Buying Property for Children
Tax Implications of Children 'Owning' Property
A QUESTION we are frequently asked is whether any tax savings are available if a parent buys property for their minor children. The answer, in a nutshell, is that such savings are theoretically possible under the right circumstances, but very difficult to achieve in practice.
A child under 18 cannot take legal title to property, so there are two ways in which the property can be held: a simple ‘bare trust’ or a more formally constituted trust, such as a life interest or discretionary trust.
Under a ‘bare trust’, another person holds the title to the property as a nominee. The property title is registered in the name of, for example: ‘Joe Bloggs as bare trustee for Samantha Bloggs’.
In all other respects, the child is regarded as the owner of the property and will automatically be entitled to take legal title to it when they reach the age of 18.
A more formally constituted trust requires a Trust Deed, which is a legal document setting out (amongst other things) who the trust beneficiaries are, who the trustees are, and how and when the trust’s income and assets should be distributed to its beneficiaries. It is possible to have any number of beneficiaries, or even just one.
When the trust acquires a property the title would be registered under something like: ‘Joe Bloggs and Davina Bloggs as trustees for the Bloggs Family Trust’.
In this case, it is the trust itself which is effectively regarded as the owner of the property and the child’s rights to the income from the property and to take title to it will depend on the terms of the Trust Deed.
Whichever type of trust is used, the major difficulty which arises is the parental settlements legislation. This legislation is triggered whenever there is any gift from a parent to their own minor child. Hence, for example, it would be triggered if the parent:
- gifts the property
- pays the deposit for the property
- contributes to the mortgage payments
The effect is that all income from the property is treated as belonging to the parent for Income Tax purposes (subject to a general exemption for income not exceeding £100 per annum).
Where a ‘bare trust’ is used, the parent will be taxed on all of the rental profits at their top rate of Income Tax. If a more formal trust is used, the parent will be taxed on any sum which would otherwise have been treated as the child’s income. With a life interest trust, this would again effectively be all of the rental profits. A discretionary trust could retain some of its profits, but this will not really help as profits in excess of £1,000 will be taxed at the ‘trust rate’ of 50%. (The trust has a basic rate band of £1,000.)
To avoid the settlements legislation will require the support of other family members or friends: typically, the child’s grandparents.
If grandparents gift the property or pay the deposit, the settlements legislation is not triggered. But parents have to be very careful: if they contribute in any way to the running of the property there is a strong chance that the settlements legislation will again be triggered. Payment of a utility or repair bill could be seen as a settlement with all the Income Tax consequences described above.
This could happen all too easily, especially if a ‘bare trust’ is being used. Remember that, under a ‘bare trust’, the parent may be the legal owner of the property and thus legally responsible for it.
Personally, therefore, if you do have the support of grandparents or other family members or friends, I would recommend using a formally constituted trust and ensuring that your child’s benefactor puts sufficient additional funds within it, as working capital, to ensure that you never have to make any contribution to the property!
Capital Gains Tax
The first point to remember is that any transfer of property to another individual (or a ‘bare trust’), other than the owner’s spouse, will be subject to CGT as if it were a sale at market value. The exemption for spouses is lost if the couple separate (after the end of the tax year of separation).
A transfer into a formal trust is similarly treated as a sale at market value. Parents transferring property into a trust for the benefit of their own minor child cannot elect to hold over the capital gain arising. Grandparents and other donors can, although this means that principal private residence relief cannot be claimed on a future sale of the property.
The good news is that the settlements legislation does not apply for Capital Gains Tax purposes.
If a bare trust is used, the child is treated as the owner of the property and is entitled to their own annual exemption and basic rate band, thus providing potential savings of up to £6,468 on a sale of the property (at 2011/12 rates). Even greater savings may be available if the child later adopts the property as their main residence as an adult.
No CGT will arise on the transfer of the legal title when the child reaches the age of 18: the child was always regarded as the owner for CGT purposes anyway.
Where a more formal trust is used, any capital gain on a sale of the property will be subject to CGT at 28% after deducting the trust’s annual exemption which will be just £5,300 at most (at 2011/12 rates).
Alternatively, the property can be transferred to the child after they reach the age of 18 and any gain arising can be held over. The child would then pay CGT on the full amount of gain arising when they sell the property, subject to all the usual reliefs and exemptions – except that principal private residence relief cannot be claimed where a previous gain has been held over on the transfer to, or from, the trust.
Tax aside, my personal view is that putting a valuable asset into the hands of an 18 year-old is only for the sort of person who would rush in where angels fear to tread; or is so wealthy that they have no reason to fear in the first place!
For this reason alone, I would tend to suggest that any property purchased purely for investment purposes is held in a formally constituted trust with a Trust Deed allowing you to delay the transfer of title in the property until the child is a bit older.
For children with generous grandparents or other benefactors, this will also help the parents to avoid the settlements legislation by introducing the necessary discipline into the way that the property is run.
Where the settlements legislation does apply, it is questionable whether this strategy is worthwhile. However, where things can be structured so that the child’s income is taxed on a parent with little or no income of their own, or where the property is highly geared, so that little income arises, the CGT savings may be enough to provide a long-term benefit.
Where the property is intended as a future principal private residence for the child, a ‘bare trust’ will probably be preferable. Avoiding the settlements legislation may be very difficult, but the long-term CGT savings could be quite considerable.
This form of planning also has many Inheritance Tax implications which we will look at in greater detail.
Making the Most of It
Without a wealthy grandparent or other benefactor, it will not be possible to avoid the settlements legislation. Its impact can, however, be reduced by ensuring that any gift to the child, or contribution to the property’s running costs, is made by the parent with the lower income.
For example, the child’s father may have decided to be a stay at home parent and may have very little income, whilst the mother may have pursued a successful career and be a higher rate taxpayer.
Let’s say these parents want to buy a property for their child. If the father provides the money to pay the deposit, he will be taxed on any rental profits until the child is 18. However, as he has little or no income of his own, he may have some of his personal allowance available and will only suffer Income Tax at 20% on any remaining balance. This is far better than if the mother had paid the deposit, as she would then have suffered Income Tax at 40% or more.In these circumstances, it may be necessary for the wealthier parent to gift the deposit money to the other parent first. This is okay: provided that there is no obligation on the recipient parent to make the onward gift for the child’s benefit. To avoid any suggestion that such an obligation existed, it may be wise to leave an interval of a few months before making the onward gift.