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How to Use Trusts to Protect Property Assets

How to Use Trusts to Protect Property Assets
Many think that trusts are complicated and expensive things but in reality, they are simply vehicles in which to hold assets for beneficiaries and from which to distribute income, if any. So why set up a Trust? Trusts are set up for the following reasons: • For convenience – the beneficiary may be a minor who is unable as yet to deal with the asset (such as a property) themselves, or the donor wants flexibility to provide for a class of beneficiaries who might not even be born at the time that the trust is created (such as grandchildren); • To mitigate taxation – property placed within a ‘Mainstream’ Trust (see below) does not form part of the donor’s estate on death and as such mitigates (reduces) any Inheritance Tax (IHT) that may become due; and for the main reason... • To protect the property - should: • The beneficiary be someone who is mentally incapable or who cannot deal or manage the property themselves; or • The property needs to be sold to pay for long term care; or • There be a bankruptcy or divorce. What is a Trust? There is no legal definition of a ‘Trust’, but HMRC have produced a working definition as follows:   ‘A trust is an obligation binding a person (a ‘trustee’) to deal with property in a particular way for the benefit of certain people (the ‘beneficiaries’) whose interests are protected by the courts.’   How a Trust is Formed Legally no formalities are required in order to create a Trust (it can be oral) unless land is involved and then the Trust must be in written format. Land or not, it is always advisable to have a formal written Trust Deed as this helps to avoid any future misunderstandings. A trust is set up by a ‘settlor’ who instructs that particular assets are removed from his/her ownership and put aside for use by a ‘beneficiary’ in the Trust; the ‘trustees’ having control of the asset. Trust assets can be in any form - real or personal, tangible or intangible. It is often shares, cash or in the form most relevant to ‘Property Tax Insider’ readers - property! Role of a Trustee The role of the Trustee is very important. The Trustees are thelegal owners of the property but they cannot use the property as if it were their own personal property. They use and keep the property secure only for the benefit of the beneficiaries. Who Can Be a Beneficiary? The beneficiaries are the real owners of the Trust property who either immediately or eventually, will receive the income from the Trust property, if any, or the property itself. The extent of an individual beneficiary's interest depends upon the wording of the Trust Deed for example, of two beneficiaries one might be entitled to the bank account interest income only but the other allowed the entire capital on his 25th birthday. Types of Trust There are two main types of Trust: 1. Qualifying Interest in Possession (QIIP) and 2. Discretionary (post Finance Act 2006, termed ‘Mainstream’ Trust). Under a QIIP, a beneficiary is entitled to the income as well as the underlying asset (property) on death whereas under a ‘Mainstream’ Trust no one is entitled to the income or assets, rather it is at the discretion of the trustees as to how both are distributed dependent upon the terms of the trust Deed. Specifically - Protection of Property Via a ‘Nil Rate Band’ Trust The ‘Nil Rate Band’ (NRB) trust scheme is a trust written into a will that allows the use of a ‘Mainstream’ trust by a spouse (or civil partner) (see below). On death a trust is created equal in value to the amount of the IHT ‘Nil Rate Band’ (currently £325,000), or the settlors’ unused NRB if already part-used. The beneficiaries can be the surviving spouse (or civil partner), the children and any other beneficiaries the testator might wish to benefit.  A ‘Mainstream’ trust format is intended to ensure that the settlors’ share of the property is not treated as part of the surviving spouse’s (or civil partner’s) estate which would otherwise defeat the point of the exercise. For the scheme to work each spouse (or civil partner) needs to own the property as ‘tenants in common’ (see ‘Property Tax Insider’ issue 10 June 2011, page 3). The surviving spouse (or civil partner) has the legal right to occupy the property (if they wish) by virtue of ownership of their own half share. The NRB trustees are deemed to own a beneficial 50% share of the property which is effectively subject to a sitting tenant; they cannot sell the property because they do not entirely own it and they probably cannot generate any income from it either. As such, the trustees' only option is to retain it as an asset of (hopefully!) appreciating value i.e. to ‘protect’ the property. The scheme adds protection as follows:- 1. Maximum flexibility over the whole estate is possible whilst still retaining the spouse (or civil partner’s) IHT exemption. 2. The entire structure can be collapsed relatively easily should the total estate amount turn out to be less than the exempt amount. 3. There will be no problems should a beneficiary become bankrupt or die. 4. Should it be necessary to sell the house whilst the beneficiary is alive, Principal Private Residence relief (PPR (see Property Tax Insider October 2010 issue 2, page 2)) is available on the whole value of the property. 5. The scheme has not been implemented during the donor’s lifetime which could also ensure that there will be no queries from the local authority that he has voluntarily divested assets, should residential care be required at a later date. If an NRB trust is provided in the deceased’s will, the remaining estate assets can be left either outright  or on a flexible life interest trust to the surviving spouse (or civil partner), so that no IHT liability arises on the first death.   HMRC may contend that the trust is, in fact, a QIIP trust in favour of the surviving spouse (or civil partner) and try to include the value of the property in the survivor’s estate (resulting in the NRB of the deceased potentially being wasted, because of the spouse (or civil partner) exemption), even if the trust is designated ‘discretionary’ or ‘Mainstream’ but especially it if it is felt that the trustees have granted the spouse the right to exclusive occupation. The interests of the trust’s beneficiaries therefore need to be protected. The surviving spouse (or civil partner) cannot be allowed to just live in the property; the Trustees need to ‘behave’ as trustees which includes notifying HMRC of the trust’s existence, completing tax forms and participating at regular trustee meetings. Practical Tip The ideal in IHT planning with reference to property that forms part of a chargeable IHT estate would be to place the property into a ‘Mainstream’ trust during the donor’s lifetime but for the donor to continue benefiting from it. Unsurprisingly this is not allowed under special rules (the ‘Gift With Reservation of Benefit’ rules) which ensure that a donor cannot transfer the property out of his estate, continue to have the use and enjoyment of the property and then after the necessary seven years the property would be completely exempt from IHT. The NRB scheme does not suffer from this potential pitfall, as the gift is included in a Will on death. By Jennifer Adams
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