Repairs on property leaving A&M trust

[Grange]

A property is in an A&M trust and has been for about 15 years. Currently one or two aspects of the property are in a poor state of repair. (The roof requires some attention, two windows require complete replacement, it hasn't been painted for about 20 years. These items are clearly outside a normal maintenance programme.)

The beneficiary's 25th Birthday is next month, so the trust is to be dissolved and legal ownership is to be given to the beneficiary as a matter of urgency. The chargeable gain will be held over.

How can we obtain a tax deduction for the repairs - which will not happen until the autumn?

Is the beneficiary entitled to a deduction - I doubt it.

Can we obtain a deduction in the trust by the trustees contracting to hand the property to the beneficiary in a good state of repair?

Does it make a difference that the trust will have to borrow money in order to undertake the repairs - money which will be borrowed from the beneficiary who will in turn borrow it from a bank?

Your thoughts, please, Ramnik if you would be so kind.

[Tax Accountant]

Mr Grange,

Trust is not my area.

Firstly, I assume that the underlying principles are no different just because it is a trust.

Secondly, I assume that the Trust is not only the legal owner but also the beneficial owner, at least until the ownership is transferred to the beneficiary. But, on the other hand, one would have expected the beneficiary to be the benecial owner until he also becomes the legal owner. If so, technically, there will be no change in the beneficial owners upon transferring the legal ownership and therefore there will be no disposal. But I suspect this is not the case and I assume that there is a disposal for CGT purposes.

But can the ownership be said to have changed hands for the purpose of deciding whether the expenditure is Revenue or Capital?

If there is a disposal, I assume this will be at deemed market value, which will reflect the dilapidated state of the property. If so, I assume that any subsequent work by the beneficiary will be classified as improvements and thus treated as capital expenditure unless the property could continue to be let without repairs being made shortly after acquisition (PIM 2020)

On the other hand, any expenditure by the current owners will be tax deductible as revenue expenditure. But the property is to be transferred next month upon the beneficiary reaching his 25th birthday. In this case, I believe that if a binding liability is entered into by the current owners before the transfer, the expenditure could be accrued and allowable as a revenue expense (PIM 2020).

Finally, if the property has (presumably) continued to be let for 15 to 20 years, I am sure that it could continue as such for a couple of more years. If so, the beneficiary should not have any problems in claiming a deduction as revenue expense.

I hope these comments are of help to you but I am sure you will understand that I cannot of course accept any responsibility for them.

Ramnik

[Tristan]

You state that the work is not being done until the Autumn, although the beneficiary is becoming absolutely entitled next month. Does this mean that the beneficiary will be funding the repairs, since they will be the legal and beneficial owner at that point?

When the beneficiary becomes absolutely entitled to the property there will be a deemed disposal for CGT purposes at the market value at that point. You state that the gain is being held over, so no tax is payable in the trust and the beneficiary's base cost for CGT purposes will be the MV at the date of entitlement, less any capital gain arising to the trustees. This effectively defers the capital gain until the beneficiary comes to sell the property.

When the beneficiary pays for the repairs in the autumn it will be necessary to consider whether these are revenue or capital. Revenue expenses should be deductible from the rent (if he is renting it out), capital expenses may be allowable as enhancement expenditure on the property when he comes to sell it.

If the beneficiary is living in the property (or will do) you should be aware that he will not get the PPR relief. It was fairly standard practice for people to wash the capital gains on investment properties by putting them through discretionary trusts claiming holdover on the way in and out, living in the property for a few months and then selling tax free. The rules were changed in 2004 such that where holdover has been claimed, PPR doesn't apply. You should therefore consider whether it is better to pay the tax on the gain to date (in the trust at 40%) and get PPR on future growth, rather than defer the tax and have no PPR on the eventual gain. If the beneficiary doesn't plan to live in the property then there is no problem.

Presumably you've calculated the IHT charge that will arise on the appointment out of trust?

Hope this helps.

Tristan

[Tristan]

Actually, as I think about my last comments, I don't think you'll be in the new trust regime yet, so you won't have an IHT charge - you'll be relying on the fact that there has been no intermediate life interest of the beneficiary to get holdover relief. Presumably your advisers have confirmed that the beneficiary stays in his "discretionary" period up to age 25 such that holdover is available.

[Grange]

Thanks, both for your comments.

Particularly Tristan for the point about PPR not applying. It is an A&M trust, not a discretionary trust. (What I know about trusts I can write on my thumb nail.) CGT was paid when the property went into trust - as a disposal into an A&M trust (as I understand it) is not subject to an immediate 20% IHT charge, therefore holdover relief may not be claimed.

When the beneficiary receives the property, I understand that holdover relief may be claimed.

Do you have a reference for this point please? I had a search of the hmrc site and drew a blank.


So far as the repairs are concerned, they would clearly be repairs within the trust. The MV of the property at the time of transfer is reduced by the cost of the repairs, so the repairs would be capital for a new recipient.

In order for a deduction to be obtained by the former owner, working on normal principles, a provision for future expenses would have to be booked in the accounts. This would require the amount to be ascertainable and for there to be a contract in place. Hence my thoughts of a contract between trustees and beneficiaries, whereby the trustees undertake to make repairs to the property.

[Tristan]

Hi

Not been on the site for some time hence the delay in seeing your further questions.

My comments on Discretionary trusts were by way of example of what people used to do before the rules were changed.

In your case, no IHT would have been payable on the establishment of the trust, hence no holdover relief was available.

When the beneficiary becomes absolutely entitled there should not be any IHT due. However, provided there was no period when the beneficiary had an "interest in possession", the trustees should be able to get holdover relief. This is under s260(2)(d) TCGA 1992. (see http://www.opsi.gov.uk/acts/acts1992/Ukpga_19920012_en_19.htm#mdiv260 if you want to check the reference)

If holdover is claimed on the way out of the trust, no tax is immediately due. The tax is deferred until the beneficiary disposes of the property. The point on PPR is that once holdover has been claimed under s260 TCGA, no PPR relief can be claimed in the future. This is contained in s226A TCGA - you won't have found this on HMRC website because the legislation was an amendment to TCGA so isn't in the published act. However, it was amended by Sch 22 FA 2004 para 6. See http://www.opsi.gov.uk/acts/acts2004/40012-bj.htm#sch22 .

So my comments previously still apply - you will need to decide whether to have a dry tax charge on the appointment out of the trust (at 40%) but retain the possibility of PPR exemption on future gains by the beneficiary, or to holdover the gain but suffer a CGT charge on the gains to date and future gains without the benefit of PPR relief.

I'm not sure I can give a specific answer on the points re the accrual of the expenses. S40 ICTA 1988 deals with the apportionment of rent/expenses between purchaser and acquirer of a property and basically says that your plan will work - i.e. if you accrue the rent in the trustees' accounts they'll get a deduction for the rent. But, s40 relates to the "sale" of a property, not the assignment out of a trust. It seems more correct that the beneficiary will get a deduction for the cost of the improvements against his capital proceeds of the eventual sale.

As you'll appreciate, these comments are for guidance only and I can't accept any responsibility for them. I'd be happy to look into the questions formally for you subject to being properly engaged. Please drop me a message if you'd like to discuss this further.

Regards

Tristan