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Real Estate & Residential property & Tax & Estate Planning

What are the tax implications of being the Bank of Mum and Dad?

Associate Andrew Mason answers a question around tax implications for parents when gifting funds towards their adult children’s homes. First published in the Financial Times as part of the ‘Your Questions’ Column.

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My husband has recently retired and we are ready to plan the next stage of our lives. Our first decision is to sell our historic but rambling country home and downsize to something more manageable. Once we have bought a cottage to live in, we would like to use the remaining proceeds to help our two sons purchase family homes of their own in London when they are ready. They are both in their 20’s now. What tax or gifting considerations do we need to account for? 

The Bank of Mum and Dad supported more than half of first-time buyers under the age of 35 in 2020, so your concerns will be widely shared.

I would first ensure you are comfortable that you can afford to make these gifts and that you will not need the funds released by downsizing to supplement your income in retirement.

The principle tax to consider when making gifts is inheritance tax (IHT). You can give away up to £3000 a year tax-free )£6000 if you haven’t made any gifts in the previous ta year). You can also make a tax-free gift to a child of up to £5000 in the year in which they get married.

Larger gifts will be “potentially exempt transfers”, commonly referred to as “seven-year rule” gifts. If you survive the gift for seven years, it will fall out of account for IHT but if you were to die within the seven years, the gift will be taxable at 40 per cent (with the potential tax ability tapering down after three years).

You should formally document any substantial gifts in a letter or deed of gift so that there is a record for future reference. A mortgage company may also require evidence of the gift, for example. If your sons will be purchasing the property with a partner, you may also consider a cohabitation agreement to determine how the property will be divided if their relationship ends.

As further security, you may wish to put the money into a trust- of which you can be the trustees. These days, the principal benefit of trusts is asset protection, rather than tax mitigation. A trust may be especially useful, therefore, if you have any concerns about how your sons might manage the money if it is not immediately invested in a house.

Provided you do not put any more than your tax-free allowance for IHT, or “nil rate band” (currently £325,000 each) into trust, there will be no immediate IHT implications of doing so, apart from starting the seven-year clock running to remove the funds from your estates. As trustees, you can continue to control the funds until such time as your sons are ready to purchase a property.

An alternative might be to lend the money to your sons. This will not reduce your IHT bill, as the loan will instead be an asset in your estates, but does offer a little more control than an outright gift. If you later choose to waive repayment of the loan, you will make a  gift of the outstanding balance at that point, which will be subject to the seven-year rule for IHT. As with gifts, any loans should be formally documented.

This was first published in the Financial Times. You can view the original publication here. A subscription is required.

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Andrew Mason

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