Tax

GUEST ARTICLE: Sub-Dividing A Home For Children - It's Not As Easy As You Think

Min Nolan, Boodle Hatfield, Solicitor, 29 June 2016

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Dividing a building to provide a home for children is an attractive idea to parents helping children with the nightmare of high property prices, but there are traps to avoid and factors to consider, as this article explains.

The ever-increasing value of residential real estate in London is well-documented. Even those with what are considered good incomes can often struggle to buy a home in a desirable location. The prospect of our children owning their own home is, for many, remote. One option, says Boodle Hatfield’s Min Nolan, is to divide the family home, creating new homes for your children. There are attractive tax benefits too, the author says. The editors invite readers who want to comment to get in touch. As always, the opinions of guest contributors are not necessarily shared by the editors.

The subdivision of the house into, for example, two or three flats is considered a material change of use and will require planning permission from your local authority. If the house is listed then listed building consent will also be needed. When considering a planning application, the local authority may consider factors such as the number of conversions in the area, and the provision of local amenities, particularly parking. Homeowners should also check to see if the house is in a conservation area as this may affect the conversion, particularly external factors such as windows. Any subdivision will also need to comply with all applicable building regulations, which cover a number of diverse areas, including the structure of the buildings, fire safety, passage of sound, ventilation and sanitation to ensure the health and safety of the people in and around the building.

Only with the relevant permissions should work begin. 

Tax
There will only be tax benefits if you are prepared to hand over control of the flats completely to your children. If the flats are gifted outright, there will not be any Stamp Duty Land Tax (SDLT) as the children are not purchasing them. If your children are taking the gifts subject to a mortgage over your property, however, there may be SDLT to pay. Your mortgage should also be checked to ensure that there is no restriction on giving away the legal title in part of your property.

The value of the gifted flats will be outside your estate for inheritance tax (IHT). If you survive seven years from the date of the gifts, IHT will not be payable on your death. It is worth bearing in mind that should you not survive seven years then the gift will become chargeable for IHT (potentially up to 40 per cent) on your death.

Importantly, you will not be able to reserve any rights of ownership over the flats, for example charging rent to your children or having free access to the flats. If you do, the gifts may be treated as gifts with a reservation of benefit, meaning they will remain part of your chargeable estate on death for IHT and there may be other negative tax implications. 

You should also be careful about retaining any benefit from the properties within seven years of making the gift in order to avoid a pre-owned assets charge (POAC). POAC is an income tax levied annually on the notional value of the benefit received by you from the property. You may incur a POAC liability if, for example, you went to live with one of your children in one of the flats, or even another property purchased with the proceeds of the flat that you had originally gifted. The anti-avoidance legislation is quite far reaching and so even receiving a loan from one of your children subsequent to your gift may attract a charge.

The downside of gifting the flats will be the potential capital gains tax charge. Currently, prior to the conversion, the house is your main residence and so you will get private residence relief (PRR), meaning CGT will not be charged on a disposal. Once the house is divided up, however, there may be an element of CGT chargeable on the additional value created by the conversion, arising on your disposal of the flats to the children. CGT may be charged on what is likely to be a relatively small proportion of the value of the flats at 18 per cent or 28 per cent. After this, as the flats will be the children's main residences, they will have their own PRR.  

Restrictions on future use
It is important to consider the potential future use of apartments created by the sub-divided the home. 

In order to avoid the gift with reservation of benefit rules, once you have gifted the flats to the children and they are the registered proprietors then you will not be able to prevent them from doing what they wish with the flats, including selling them. This is an important consideration practically, as you may well end up sharing the house with neighbours whom you have not chosen. Should your children wish to protect their flats from divorce or bankruptcy, they should carry out their own estate planning and consider putting in place a prenuptial or postnuptial agreement.

Although there are some tax benefits to be had in converting the family home into flats for your children, these should be carefully weighed up against various factors. These include the costs of the conversion, not least the fees of professional advisors, but also the practical implications of such an exercise and how the restraints outlined above to avoid reserving any benefit from the flats, and that the likelihood your children will want to sell eventually may impact your lifestyle in the future.

Nolan is a solicitor in the private client and tax team at law firm Boodle Hatfield

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