You may think that having a Trust for your adult kids is a very sensible thing to do, indeed what could possibly go wrong? But the truth is that there are a number of potential tax pitfalls when parents transfer investment property into a discretionary trust for their adult children. Tax Expert Brona MacDougall takes a closer look.
A parent with sufficient means may sometimes wish to transfer an income producing asset. For example, a mother may wish to transfer investment property into a discretionary trust for her son to help with his university costs or to supplement income when buying his own home.
However, there are various tax issues to consider in the above example of property gifted to a UK resident discretionary trust for adult children. This article highlights a selection of potential tax implications which you should consider, please note, further potential pitfalls may arise if the children are minors.
Trust is income?
Income tax anti-avoidance (‘settlements’) legislation can result in the trust’s rental property income being treated as the parent’s income in the above example, if her child is under 18.
For inheritance tax purposes, the parent donor and their spouse should be excluded from being a beneficiary of the trust in terms of preventing a possible charge under the ‘gifts with reservation’ IHT anti-avoidance rules. HMRC’s view is that if there is a settlement power to add beneficiaries, the GWR rules could apply. Consideration should therefore be given to ensuring that the parent donor is explicitly prevented from being added as a trust beneficiary.
One relief, not two!
A parent may wish to gift a buy-to-let property into trust, which subsequently becomes the private residence of their adult child as a trust beneficiary. The parent might intend ‘holding over’ any gain on the property disposal for capital gains tax (CGT) purposes, and the trustees may intend claiming private residence relief on a subsequent disposal of the property.
However, anti-avoidance provisions are aimed at blocking private residence relief in such circumstances on a subsequent disposal of the residence. This restriction applies broadly where the property’s base cost would (if private residence relief was not available) have been reduced following one or more holdover claims on an earlier disposal. Private residence relief would not be available on the later disposal.
No room for guesswork
For IHT purposes, the property transfer to a discretionary trust will be an immediately chargeable lifetime transfer. This could result in IHT reporting and payment obligations.
HMRC enquiries into land valuations sometimes produce large amounts of additional IHT and interest, because many valuations are too low. HMRC may also seek to impose penalties if an undervaluation has arisen because ‘reasonable care’ was not taken. A professional valuation of the property interest for IHT purposes should therefore be undertaken.
The above tax considerations are not an exhaustive list and there may be other tax implications to consider, such as Land and Buildings Transaction Tax in Scotland, depending on the circumstances. If you are planning on transferring property into a trust for your children, there are definitely potential tax implications and pitfalls to consider and JRW can advise what might be best for you and your individual circumstances.