I have heard that it is possible to reduce IHT by making a loan to someone. Can someone explain? Does the loan have to be interest free? What is the position if the person making the loan dies before it is repaid? What is the position if the loan is repaid before death? Can someone please give an example, showing IHT implications?
I don't think there are in general any IHT implications if there is a loan made by the person whose estate is of interest. If X lends £Y to Z and then drops dead, then whatever Z owed X will instead simply be owed to X's estate. If Z also happens to be a major beneficiary of X's estate, inheriting more than what he owes, then the money may not need physically to change hands twice, but it still counts as part of the estate and will be taxed as such.
There's more scope for fun and games with loans made *to* the deceased (while still alive, obviously).
The heirs might lend their benefactors money with which they could make annual small gifts back to the heirs. That way the heirs could get their hands on entitlement to the money before getting the money itself. Upon death, all the money previously gifted would be outwith the estate because it is a debt. In addition, the heirs could be getting interest (if not excessive).
One of the big bogies is parents gifting their house to the children but continuing to live in them rent-free. These would be "Gifts With Reservation" and as such will be counted as part of the estate, will be valued at date of death rather than of gift, and will probably be treated for CGT purposes as acquired at the time and value of the gift.
Two ways go avoid treatment as GWR are:
1) If the parents pay a market rent to the children for the right to continue living there.
2) If the children actually buy the house at market value off the parents.
I speculate that it might be possible, in case (1), if the parents don't have money to spare to pay this rent, that the children might lend them the money, by letting an account of rent arrears accrue, to be settled from the remaining estate, if any, after death. That should change the GWR into a PET, and might thereby take the house out of the scope of IHT after 7 years.
As for (2), there may be some way the children could borrow money from a third party to buy the house off the parents, the parents would then gift them the money, the children could then repay the third party loan (in fact, the third party could be the parents). That way, although in effect the parents gifted them the house, technically they gifted them a sum of money, and it's not really possible to reserve beneficial interest in a sum of money (or is it?), and so the money would be a PET, not a GWR. Even if it were a GWR, the value would be that of the money itself, not of the house, so if the house appreciates between time of transaction and time of death, IHT would be charged only on the basis of the money at the time it was given, not of the house at death.
I think this could be fine-tuned, so that the children might not get gifted the whole money. The parents would keep enough with which to pay them rent, or buy a lifetime lease.
Well, as I said, to reduce IHT. If my father, for example, who has assets of about 500k were to make a loan or loans to his children, would that affect his IHT position? Would they need to be interest free? Say he loans 200k. What would the IHT position be on his demise?
Essentially unchanged from what the position would be if he didn't give you the money until after his demise. The children would owe the £200k back to the estate, whether or not interest was charged. The whole estate would then be taxed in the usual way. Then, assuming you are the sole heirs, you would get the money back, plus the rest of the estate, minus tax.
If there is enough liquid money in the £300k from which to pay all the tax due on the £500k (less the exempt amount, currently £255k), you wouldn't actually need to part temporarily with any of the £200k, but if there isn't, and you had spent the £200k, someone will have to borrow the tax money before the rest of the estate is released.
It's not quite like this. It's possible to set up a trust where the loan is in the form of an investment and the growth on the investment is outside the estate. This means that at the years go by, and if the lender takes back some money from the loan gradually (and spends it), he's reducing the value of his estate little by little.
If he wants make a significant impact on his IHT position immediately he might be better with a discounted gift trust.
[THINKS] I bet their Father is a divorced 45 year old who plays squash every day. Either that or an 85 year old widower on a geriatric ward awaiting a bypass. Either that or a...
Is it possible to take out a mortgage on the property, use this to take out an investment bond owned jointly with the children, or in trust, use the income from the bond to fund the interest payments on the mortgage. On death (after seven years / due gift inter-vidos in the meantime for the investment amount), the trust / investment is outside of the estate but the mortgage is in the estate?
Still working through G10 so not sure if I have it exactly right yet. By the way, anyone know of any G10 study groups in the sussex area? sorry to go off topic.
My father-in-law set up a "gift and loan trust" (aka "legacy loan trust" if the OP wants to do a web search). I think it allowed him to draw 5% p.a. tax free
And remember that you have to pay the IH tax before you get control of the assets. This means, typically, that you have to borrow the money form the bank to pay the tax until you can get probate and therefore the ability to realise the assets and pay back the loan. BUT if some of the money is invested with national savings then you can direct them to pay that money to pay the IHT.
I think this could work but the mortgage payments would be regarded as PETs back into the estate. You've also got the possibility that the bond withdrawals might be greater than the bond growth as happened with many people in the 80s who took out equity release plans based on this structure and ran into a whole heap of trouble when growth went down and interest rates went up.
They can be, Its just that IME many existing gift & loan schemes appear to have been used merely as a way of selling a with profits bond which, as you know, is the only form of investment some Financial Advisers use (apart from £7k into an ISA).
I dont follow this. The mortgage payments are being made by the borrower to reduce his debt.
If the investment bond premium was made as a capital gift to the trust thenn this would be a PET. If a discounted cash gift were made and the withdrawals arranged through an IHT trust that allowed reversion of capital without reservation of interest, then the withdrawals would enable the value of the PET to be discounted. If thePremium was a loan to the trust then the annual withdrawals would be neutral form an IHT point of view.
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