Tax Implications of a “Granny Annexe”

A Telegraph reader asked for advice on how a “granny Annexe” at her home could affect Inheritance Tax.

About a dozen years back, Ruth and her husband sold their homes along with Ruth’s parents. Together, they pooled their proceeds to buy a house with an attached annexe, costing £360,000. The house was registered in the joint names of Ruth and her husband. Ruth became the full-time carer for her parents, who did not pay rent but contributed towards monthly bills. They also used their savings to fund Ruth’s son’s university accommodation and offered frequent cash gifts to the family.

The Inheritance Tax Conundrum

Ruth’s primary concern is about the implications of inheritance tax and the £3,000 annual gift limit.

When viewed from HM Revenue & Customs (HMRC)’s perspective:

  • The property that Ruth and her family purchased, despite being registered under Ruth and her husband’s names, was essentially funded equally by both parties.
  • Technically, Ruth’s parents gifted their share of the property to Ruth and her husband. However, the HMRC might classify this as a “gift with a reservation of benefit” because the parents still reside in the annexe without paying rent. This type of gift is not exempted from inheritance tax.
  • If Ruth’s parents had been paying a market rent for the annexe or if they hadn’t sold their original house, certain inheritance tax implications could have been avoided.

To boil it down, half of the new house’s value still counts towards the parents’ estate for inheritance tax.

The Annual Gift Allowance

Ruth’s parents have generously been providing for their grandson’s university and giving regular gifts to the family. The HMRC has set an annual gift allowance of £3,000 for each individual. In Ruth’s parents’ case, they can jointly gift up to £6,000 each year. Any amount gifted under this allowance is immediately excluded from the estate’s value for inheritance tax purposes.

However, with current savings and property value, and considering the individual tax-free nil-rate bands, Ruth’s parents’ estate would only be liable for inheritance tax if it exceeds £1 million.

Inheritance Tax, House Valuation, and Care Needs

When evaluating a property’s worth upon the death of an owner, the HMRC may discount shares of less than 100% by roughly 10%. This principle considers shared ownership as less attractive than full ownership. Hence, unless the house’s value has skyrocketed over the last 12 years, Ruth’s parents’ estate probably won’t be subject to inheritance tax.

However, another consideration is future care requirements. If one of Ruth’s parents needs care, their share in the house may be disregarded by the local authority when determining the cost of care. However, complexities arise if both require care or if one passes away when the other needs it.

Gift Interpretation Differences

Inheritance tax rules can sometimes be perplexing. For example, while a gift might be valid for tax purposes if made more than seven years ago, the same gift might not be viewed the same way when considering care costs. In simpler terms, while the law might acknowledge Ruth and her husband as the owners of the annexe, the HMRC might still consider it an asset of Ruth’s parents for tax purposes.

The same principle applies to the gifts made for Ruth’s son’s education. While they might be tax-exempt, local authorities might perceive them as intentional moves to evade care costs.

A Way Forward

For clarity in situations like Ruth’s:

  1. Documentation: Always document the intent behind significant financial decisions. This could be done through a “Declaration of Trust”, which details ownerships, payments, and what happens in case of a sale or death.
  2. State Intentions for Gifts: For gifts, it’s beneficial to document the reason behind them, such as supporting a loved one’s education.
  3. Explore Benefits: Given Ruth’s role as a full-time carer, her parents might be eligible for Attendance Allowance, a non-means-tested benefit.

Wrapping Up

Ruth’s situation highlights the intricacies of inheritance tax, property ownership, and gift allowances. Proper planning, awareness, and documentation can help navigate these complexities, ensuring that families can make informed decisions for their future.