Tax efficient gifts of the family homeMatthew Hutton examines options for inheritance tax efficient gifts of the family home in the wills of married couplesIn advising a married couple on inheritance tax mitigation, it is axiomatic that under the will of the first to die value within the nil-rate band should be left away from the estate of the surviving spouse.

Failure to do so, in a case where inheritance tax is in point, can cost up to 93,600 in 2000/01 (40% of the nil-rate band of 234,000).

If suitable assets can be found, the will could create a nil-rate band discretionary trust of, for example, stocks and shares, the income - and perhaps capital - of which could be used to benefit the survivor, but without the underlying assets forming part of the chargeable estate on the second death.

However, often the values of the estates are above the taxable limit, but on the first death such a nil-rate band trust cannot sensibly be constituted without recourse in part at least to the family home.It is clear that, in some cases at least in the past, the Capital Taxes Office (CTO) has accepted that constitution of the trust in whole or in part with a share in the family home (where the survivor owns the other half share as tenant in common) does not result in the trust's share forming part of the survivor's estate on the second death.

However, the CTO is on record (in statement of practice SP 7/89) as regarding such state of affairs as capable of creating an interest in possession, where the trustees exercise their powers to provide the survivor with a permanent home, and therefore taxable on the second death under s.49(1) of the Inheritance Tax Act 1984 (IHTA).

There are arguments that such a view is wrong in law, but all the same it is best to avoid discretionary will trusts of houses.The will should not prevent the trustees from restricting continuing occupation of the home by the survivor, who in effect should be given a veto on sale for so long as he or she wishes to live there, with the rights of the children postponed to the second death.

The High Court held in IRC v Lloyd's Private Banking Ltd [1998] STC 559 that the right to continuing occupation amounted to an interest in possession.

More recently, in Woodhall (Personal Representative of Woodhall deceased) v IRC [2000] SpC 261 occupation by one of two siblings equally entitled under their father's will was held to constitute an interest in possession in one half of the house.

What other possibilities are there? An absolute gift of the half share to one or more children will not trigger inheritance tax on the second death.

However, such a structure would be vulnerable to insolvency or matrimonial proceedings on the part of the children and could therefore prejudice the survivor's security of tenure.

Furthermore, typically the children will be living elsewhere and therefore any gain in the half share will not benefit from main residence relief from capital gains tax.

A trust structure might be preferable, in terms both of ensuring security of tenure and of obtaining the capital gains tax advantage.Life interest trustThe will could establish an express life interest trust as to say 10% for the widow and 90% for the children.

The children must be entitled to occupy and should not be prevented from doing so (important in the context of s.13 Trusts of Land and Appointment of Trustees Act 1996).

On her death the widow will be treated as owning just 55% of the house.

However, if the house were sold at a gain the trustees' half would be exempt under s.225 of the Taxable Chargeable Gains Act 1992, with there being no pro rata restriction to the widow's share.Settlement by childConsider an outright gift of the half share from father to son, who would settle the half share on his mother for life with remainder to himself for life and absolute remainders over.

The father's nil-rate band would thus be used.

The mother would have security of tenure during her lifetime, with s.225 relief on sale of the house at a gain.

The tax-free uplift to market value on the mother's death would apply.

On the mother's death there would be reverter to settlor protection from inheritance tax under s.53(3) of the IHTA 1984.

One danger with this route is the initial loss of security of tenure.

Second, the child must take action himself and not act in accordance with his father's wishes (even if not in writing), since otherwise s.143 IHTA 1984 would treat the settlement as made by the father, with no use of the nil-rate band on his death and consequent loss of reverter to settlor exemption on the second death.Debt or charge schemeThe gift of the half share could be made outright to the survivor.

The nil-rate band would be constituted, pursuant to powers in the will, by either a debt owed by the survivor personally to the trustees or by a charge (legal or equitable) imposed by the personal representatives on the share in the house assented to the survivor.

The debt or charge would be repayable on demand.

While the debt or charge could carry interest, the trustees would in practice not collect it.

The charge could be index-linked or, perhaps preferably, the loan could be expressed to be a proportion of the value of the house from time to time.

The main point to watch arises under s.103 Finance Act 1986: there will be a denial of a deduction for the debt on the second death to the extent of any lifetime gifts made - even within the spouse exemption - by the survivor to the first to die during their joint lifetimes.

If so, it would be preferable to adopt the charge scheme and, if a replacement home is to be purchased, residue should be left to life interest trustees for the survivor, obviating any s.103 risk on her death.The CTO has accepted the principle of the scheme, subject to the details.Lease for lifeConsider a bequest by a husband of his half share to his children.

The widow would sell to the children her half share in the freehold in consideration of a lease for life of the whole property.

This would be a transaction for full value, with no reservation of benefit.

Equality money and perhaps also ad valorem stamp duty might have to be paid.

The lease for life would have been acquired for full consideration and is not therefore a statutory settlement under s.43(3) of the IHTA 1984.

The widow would have security and be left with a depreciating asset in her estate.

The main downside would be a lack of main residence relief from capital gains tax for the children's appreciating asset.In conclusion, there are no easy answers to this often vexed question.

Each case must be taken on its own facts.Matthew Hutton is a chartered tax adviser and the author of Tolley's Tax Planning for Private Residences (3rd Edition)