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'How do I protect money lent to my parents in the form of an equity release mortgage from my siblings?
Ask an expert: A reader wants to take out a loan for her parents in order to fund their new home, but asks how to protect the sum from her siblings when the estate is divided up in future
My parents need to move house from their retirement property in Devon closer to where the rest of the family live in Hertfordshire. Unfortunately, the house price differential between Hertfordshire and Devon does not work in their favour and they will need me to help bridge the difference for them.
I can lend them the money, but since I am not the only sibling I want to protect this sum by entering into a loan agreement. They can’t afford to make interest and capital repayments to me during their lifetimes.
I am considering setting up a loan in the form of an equity release mortgage. I would have a charge over their property and would recover my loan with rolled-up interest from their estate in future. They would make no payments in the meantime.
Would the interest on the loan only be taxable in my hands when paid rather than accrued? Would my claim sit ahead of a local authority should the property need to be sold to fund care fees in the future?
And, lastly, if I forgave the loan in the future in exchange for a higher share of the estate, would there be a tax consequence for either myself or the estate?
KR, Hertfordshire
Jason Butler, a chartered financial planner at Bloomsbury Wealth, said this type of question comes up frequently.
If the reader does decide to charge her parents interest on the loan, but rolls this up until the loan is repaid by her parent’s estate, then the interest would be treated as her taxable income in the tax year in which it is actually paid, Mr Butler said. Making the loan interest-free avoids the income tax.
“As long as KR’s loan is properly documented by way of a formal loan agreement and her parents had no reason to think that either of them would require long-term care over the next few years, then KR’s loan should be deductible from her parents’ assets for the purposes of care fees assessment and local authority care funding,” he said.
“A first legal charge against her parents’ property is not strictly necessary to enforce her loan rights, but it might avoid any future dispute with either the local authority or her siblings.”
If KR forgave the loan, it would be treated as a “potentially exempt transfer” to her parents for inheritance tax (IHT), which would increase their estate and potential IHT arising.
Given that KR is highly likely to survive her parents, and as long as the loan is actually repaid by the estate before the residual estate is distributed, she should wait to be repaid from her parents’ estate after their demise. She should, however, ensure that both her parents have valid wills which reflect their wishes for distributing the residual estate (i.e. after repayment of her loan) between herself, her siblings and any other beneficiaries.
“One alternative approach would be for KR to set up a trust for her parents and lend the trust the money,” Mr Butler added. “The trust would then buy a share of her parents’ new property. The trustees would qualify for 'main residence relief’ for capital gains tax.
“The trust’s share of the property would be outside her parents’ estates for IHT. KR would be a beneficiary under the trust and would therefore get her investment back, tax free, on the death of her second parent. There would be no income tax issues relating to loan interest to worry about and the trust assets should be excluded from care fees assessment.”
To choose the most appropriate option and ensure that the associated documentation is drawn up correctly, it is of course advisable that KR seek professional legal and tax advice from a solicitor.
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