Back to Basics: Trusts buying properties

In the UK, your home is likely to be the most valuable asset you own – even more so in recent years with the rise in property prices.

As such, it is unsurprising that there is a growing trend to protect your home. Not just to ensure stability during your lifetime, but also as an asset that will likely grow in value for future generations.

In this article, we will consider the growing trend of trusts acquiring or inheriting property and the advantages and disadvantages that come with this type of ownership. 

Trusts and their relationship with land is by no means a new concept.

In fact, if you own your property jointly with someone else, an implied trust is automatically created under section 36(2) of the Law of Property Act 1925.

What is new, however, are the reasons why people might be choosing to create settlements during their lifetime to create trusts within a will which specifically factor in their properties. 

Life interest trusts 

One of the growing trends we are seeing is the increase in life interest trusts (immediate post-death interest trusts) in wills and this is largely down to the rise in blended families.

A life interest trust included in a will has the effect of ensuring you balance the needs of everyone, helping you to safeguard the financial security of your current spouse while still protecting your children’s inheritance for the future.

This allows your spouse or partner, known as the ‘life tenant’, to use the house, including moving, for their lifetime or until they go into care. (Some clients like to add in remarrying or cohabiting, too.)

The partner still needs to maintain and insure the property. When they no longer need the home the share in the trust is passed to the ultimate beneficiaries.

The advantage of protecting your assets in this way is that the partner never owns the asset – in this case your share in the property in trust – they are just the life tenant.

So should they need care in the future, only their assets will be taken into consideration as they do not own or have any right to the capital contained within the trust, only the income. 

Example 1 

Emma (72) and Evan (74) have been married for 20 years. They have both been married before and each have two children from previous relationships.

When they got married, they made the decision to purchase a property together as tenants in common, in order to protect their children’s inheritance in the future. The property was originally purchased with both spouses contributing 50%.   

Five years ago, they made similar wills which included a life interest trust for their spouse. The trust itself allows the surviving spouse to reside in the property until their death and includes clauses which allow for them to purchase a replacement property.

Should a replacement property be purchased at a reduced sum the surviving spouse is entitled to any income that may arise during the trust period.  

Following the end of the trust period the remaindermen become absolutely entitled to the capital. The remaindermen are Emma and Evan’s respective children. The trustees are the executors of the will, being each other and their respective children.  

On 18 January 2022, Evan passed away which triggered the life interest property trust, so half the house is placed into the trust. Opinion in the profession is divided as to whether or not a grant of probate is obtained for his estate.

For the purposes of this article, we will assume the executors have dealt with Evan’s estate and do not and will not require advice regarding this. We are considering the trust itself. 

This article also does not consider how the trust is protected on HM Land Registry, but it’s expected that, at the very least, a Form B restriction would be added to the title.

Following Evan’s death, Emma’s health deteriorated and she had to move into a care home. Emma had more than £23,250 in savings and following an assessment was not entitled to continuing care funding, and as such was required to pay her own care fees.  

Prior to Emma moving into a care home she retired as trustee and her mental capacity was not in question. 

At this point the trustees have a few things they need to consider. The main thing is whether the trustees are going to keep the trust asset invested and, if so, will that asset be income producing or will they look at winding the trust up. For the purposes of this article we will not go into depth on this particular option. 

Options available to trustees 

Option 1: assets remain in the trust 

The first option is keeping the trust asset in the trust itself. As we already know the asset is currently a half share of the property. Keeping the asset in the trust, there are few options available to the trustees: 

• take no action and the asset remains the same with the same purpose 
• the asset remains the same but the use of the property changes, and 
• the property is sold and funds are invested. 

When considering the options above the trustees need to keep in mind their duty of care imposed by section 1(1) of the Trustee Act 2000 (TA 2000).

It is particularly important that trustees consider section 3 of the TA 2000, as this gives the trustees the power to make any kind of investment as if they were absolutely entitled to the asset of the trust. This gives the trustees a lot of flexibility on the kind of investments made, but still imposes the statutory duty of care – so trustees have to balance the power in section 3 with the duty of section 1(1).

What this means for the trustee is that while they have the flexibility to act as if they are entitled to the trust asset, they also need to act as if they had a moral obligation to provide for others (see Re Whiteley (1886) 33 Ch D 347 at 355). 

Take no action and the asset remains the same with the same purpose 

When considering all the options available to them, the trustees also need to consider the needs of the beneficiaries of the trust. In these circumstances the trustees need to keep in mind that the property is only half owned by Emma, the life tenant, and Emma may need to liquidate her share of the property in order to cover her residential care costs. If that is the case, then this option will not be available to the trustees.  

If we assume that Emma does not need to liquidate her share of the trust property and is happy for it to remain as it is, the trustees need to consider their responsibilities which will include a joint responsibility to maintain the property in the trust. This will include the structure, exterior, interior, being responsible for half the costs associated with the property and keeping the property accurately insured.

Trustees need to consider whether the trust can afford to cover these costs, if not then this will not be a plausible option for the trustees.  

Realistically, for the trust to keep a property in the trust empty will only be an option on rare occasions. 

The asset remains the same but the use of the property changes 

Following on from the above assumption that Emma does not need to liquidate her share of the trust property, the trustees can consider turning the property into a rental property.

To do so the trustees will need to work with Emma as she owns a half share of the property. She will be entitled to half of any income earned at the property as part owner, but she will also be entitled to any income earned by the trust as life tenant.

So effectively Emma would receive all income earned from renting the property and considerations will need to be taken as to whether this fits Emma’s needs.   

When a trust lets a property held in trust it is best practice to consider the standards exercised commonly by landlords, especially in these circumstances. While Emma does own half of the property the trustees are likely to carry the majority of the burden of a landlord due to Emma’s ill health.

So the trustees need to consider the time and costs associated with letting a property out, including but not limited to: 

• insurance 
• repair and maintenance, and 
• fire, gas and electrical safety. 

Most trustees would employ an agent to deal with matters that would reduce the income. The trustees also need to consider what might happen if the tenants decide not to vacate the property at the end of the tenancy, or do not leave the property in the condition in which they found it.

As the only asset of the trust is the property, the trustees will need to consider whether it would be beneficial to let the property out and if the income is going to outweigh the cost.  

Property is sold and funds are invested 

The trustees also have the ability to sell the property and investigate alternative means of investment.  

Trustees will need to pay particular attention to the standard investment criteria at section 4(1) of the TA 2000 which requires trustees to do the following: 

• look at both the kind of investment and the particular investment of that kind, and 
• have regard to the need for diversification. 

Section 5 makes it clear that trustees should seek and obtain proper advice about how to exercise the above criteria. Essentially, before reinvesting the funds trustees will need to seek and obtain advice on how to best invest the funds that become available following the sale of the property.  

Option 2: Wind the trust up 

As Emma no longer needs the property as a home, the trust can be wound up before her death if the will contains an express power of advancement / appointment. 

Taxation on life interest trusts 

The treatment of inheritance tax (IHT) for life interest trusts is very different from other trusts. On the death of the life tenant, despite never owning the trust property and only being entitled to the income from it, the trust property is aggregated with the life tenant’s death estate and IHT will be calculated to include, in this case, the share of the property. 

However, unlike other trusts including discretionary trusts, life interest trusts do not incur exit and anniversary charges. This will depend on whether they are a qualifying life trust.

The life tenant should check if they need to pay tax on any income they receive from the trust. This income may be mandated to them or paid each quarter, say, to take into account any expenses that the property incurs.

If the life tenant lives in the trust property then on its sale, or their death, no CGT will be due.

Discretionary trusts 

Another form of trust which is widely used in the context of property is a discretionary trust. For the purposes of this article, we will only consider the tax implications of a discretionary trust created from a will and will not consider settlements created during the lifetime of the settlor and their tax consequences. 

While no longer required due to the changes in the treatment of the transferable nil-rate band (NRB) in 2007, for a long time discretionary trusts were standardised in wills to ensure that the NRB would not be lost on the death of the first spouse.

However, a large number of people have not reviewed their wills since these changes were made, resulting in a number of families debating whether or not to keep the discretionary trust going or to wind it up within the first two years after the death of their loved one. 

The possible advantages for keeping the trust going is the treatment of IHT. The NRB is currently frozen at £325,000 and it is expected to remain frozen until April 2028.

Consequently, if assets are retained in the trust, then there could be IHT savings if the surviving spouse’s own estate is above the NRB, to avoid increasing their estate and consequently their tax liability on their death. This is a direct juxtaposition to how IHT is dealt with for a life interest trust. 

In addition, the discretionary trust by its very nature provides the trustees with complete discretion over how to distribute the trust. This can be highly beneficial in certain circumstances, specifically in relation to care fees. 

Example 2 

Mr and Mrs Smith have little in the way of assets beyond their main home which is worth in the region of £650,000. Both Mr and Mrs Smith have included a NRB discretionary trust in their will with the beneficiaries being each other and their daughter Claire.

Mrs Smith passes away and the discretionary trust is established, with half the property now being owned by the trust.

Mr Smith, struggling with ill health, moves into a care home where he resides for a number of years. The property needs to be sold to pay for Mr Smith’s care.

Fortunately, however, because half the property is owned by the trust, Mr Smith only owns £325,000 of the property meaning the remaining £325,000 is safeguarded for Claire in the future.   

This fortuitous decision to create a NRB discretionary trust has become a safeguarding measure to ensure all the family wealth is not spent on care. 

Depending on the use of the property, the discretionary trust may also benefit from additional tax reliefs but these will be examined more closely in the example below. 

Example 3 

Mr Roberts passed away in 2014, leaving a wife and two children. He and his wife had both included the NRB discretionary trusts in their will from advice they had received in 2004.

The executors, trustees and beneficiaries of the Roberts’ NRB discretionary trust are Mr Roberts’ wife, Helen, and their two children, Fred and Josie.

Within two years of Mr Roberts’ death, Helen, Fred and Josie had agreed to keep the trust which would own £325,000 of Mr and Mrs Roberts property.

The trustees of the Roberts’ trust have now approached the firm for general advice. Given recent changes to income tax and capital gains tax (CGT) they are considering whether it is appropriate for the trust to remain in trust and want guidance on the options available to them. 

Here each tax position should be considered for whether they decide to: 

• rent the property out, 
• have a beneficiary live in the property
• or sell the property.  

Trust to let the property out 

Helen, Fred and Josie are considering whether it may be better for Helen to move in with Josie and to let the property out. 

Income tax 

If the trustees decide to let the property out they will be required to pay income tax on the rental income they receive, as the trustees are taxpayers in their own right.

Trustees of a discretionary trust generally pay 45% income tax The exceptions are in relation to dividend income (which is taxed at 39.35%) and in relation to the first £1,000 of income each year (which is taxed at 20%, or 7.5% for dividend income)

However, as the trustees are receiving a rental income they can set off their expenses incurred in connection with generating this income in the same way as individuals can. 

The trustees will have to submit annual tax returns to HM Revenue and Customs (HMRC) which will often be sent to them, or their adviser, shortly after 6 April each year. If no such return is received, the trustees should contact HMRC or their adviser to request one (assuming rental income continues to be generated).

Assuming that the trustees all equally distribute the income between themselves as beneficiaries, all income received by the beneficiaries is treated as though it has already been taxed at 45%.

If any of them are already additional rate taxpayers there will be no more tax to pay but they may be able to claim tax back on trust income they have received if they are not a taxpayer or are a lower rate tax payer. 

Capital gains tax 

Trustees of a discretionary settlement pay CGT in a manner similar to individuals. The current rate at which CGT is payable is 28% for disposals of residential property. 

The trustees will receive an annual exemption equivalent to a maximum of one half of the annual exemption available to individuals.  

When dealing with let properties the trustee’s will only need to consider the CGT position when disposing of the property.  

Inheritance tax 

There is also a potential charge to IHT every 10 years, on the tenth anniversary of the creation of the trust, for example 10 years on from the death of Mr Roberts. This is known as a periodic or principal charge. If the property is sold and the trust fund distributed, this would result in an exit charge. 

As the law stands, the calculation of the exit charge and the periodic or principal charge means that the maximum rate of tax which can apply on any of these occasions is 6% of the value of the assets in the settlement.

The actual rate, which is a rather complex calculation, is likely to be significantly less than this and therefore compares favourably with the 40% IHT rate that would otherwise apply if the assets were in your estate at the time of your death.  

Beneficiary to reside in trust property 

Income tax 

If Helen were to remain in the property, assuming the other trustees do not charge her rent, there will be no income tax liability. 

Capital gains tax 

While Helen resides in the property there will be no CGT to pay. Should the trustees in the future decide to dispose of the property there should be no CGT liability as the trustees can claim the private residence relief.  

Inheritance tax 

The taxation is the same as if the property were rented out above.  

Sell the property 

Helen, Fred and Josie are considering whether it may be better for Helen to move in with Josie and to sell the property. 

There is no income or inheritance tax consideration when selling a property, but the trustees will need to consider the CGT position.  

Capital gains tax 

As Helen has been residing in the property continuously and is a beneficiary of the trust, the trustees will be able to claim the private residence relief which will result in no CGT liability.  

Other trust considerations 

Trust registration service 

Since the introduction of the Fifth Money Laundering Directive Regulations (5MLD) which were bought into force in October 2020, it is now necessary for all express trusts to be registered, unless otherwise excluded. It is important that the trustees consider whether the life interest trust requires registering, and if it does, when.  

It is also particularly important for solicitors to consider whether the trust needs registering before taking a full instruction from the trustee.  

A trust created by a will that holds only property from the estate of the deceased person is excluded from registration as an express trust for a period of up to two years from the date of death under Schedule 3A(7) to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on Payer) Regulations 2017 (MLR 2017). 

If we return to example 1, on the face of it, this trust is excluded from registration until two years following Evan’s death, meaning the trust will need to be registered on or before 18 January 2024. A full list can be found in the HM Revenue and Customs Trust Registration Service Manual.

The trustees should consider whether any other exemptions might apply to this trust. You can find a full list on the HMRC Trust Registration Service (TRS) Manual. 

The trustees will also need to consider the requirement to register the property itself on the trust registration service (TRS).

As the property is held as tenants in common, if the trustees and beneficiaries are different then the exemption available under Schedule 3A(9) to the MLR 2017 no longer applies and the property should be registered on the TRS.

It is especially important that trustees understand the property should be registered within 90 days of the change. In the circumstances this will mean within 90 days of Evan’s death.