Sarah’s son John is starting university next year. Sarah has been researching the costs of putting a child through higher education with mounting horror.

She has been looking at accommodation costs and is considering buying a property for John to live in, having calculated that over a three-year degree the savings on money “lost” through rent could be significant and that there is also scope for capital appreciation. The property will also be let out to other students.

This article considers Sarah’s options for structuring the purchase, including the main property issues, the tax implications and the question of asset protection.

Option 1: Sarah as buyer

A. Property issues

Any mortgage Sarah takes will need to be a “buy-to-let” product and the lender is likely to insist that the property is let under an assured shorthold tenancy (“AST”). Certain requirements must be met for a tenancy to be an AST. Sarah, as a landlord, will need to comply with many regulatory requirements, and may wish to appoint a professional letting agent to deal with the initial letting and ongoing management.

B. Tax / asset protection

Inheritance Tax (“IHT”): The property value and any increase are in Sarah’s estate for IHT purposes.

Capital Gains Tax (“CGT”): Individuals occupying a property as their main residence can claim principal private residence relief (“PPR”) from CGT when they dispose of the property. If a person qualifies for PPR, but the property (or parts of it) were let during the period of ownership, he or she may also be able to claim lettings relief for the periods when it was rented out.

Unless Sarah lives in the property as her main residence at some point during her ownership, she will not qualify for PPR, and will have to pay CGT on any gain on its disposal. If she does qualify for some PPR, she may also qualify for lettings relief.

Income Tax (“IT”): Sarah will have to pay IT on any rental income received. Although this option is not attractive from a tax planning perspective, a significant advantage from an asset protection perspective is that Sarah retains complete control over the property.

Option 2: Sarah and John as buyers

A. Property issues

John and Sarah can hold their beneficial interests in the property as joint tenants or as tenants-in-common. As joint tenants, on the death of one co-owner, the property will automatically pass to the survivor. However, on the death of a tenant in common, that person’s share in the property will pass under the terms of his or her Will. If they are to be tenants in common, both should review their Wills.

Since John would live in the property, instead of granting an AST, Sarah and John could grant licences to occupy rooms to other students.  

B. Tax / asset protection

IHT: The property value, and any increase in this, is divided between Sarah and John’s estates in accordance with their beneficial ownership.  

CGT: The property is John’s main residence, so he should be able to claim PPR on his share on any disposal, and may be able to claim lettings relief if appropriate.

The same comments apply to Sarah’s share as set out in Option 1 above.

IT: The rental income will be attributed to Sarah and John in accordance with their beneficial ownership, and each will have to pay IT on his or her rental income.

This option is slightly better for Sarah from an IHT perspective, as it removes part of the value of the property from her estate. There are still issues in relation to CGT for Sarah, but John has fewer of these.  

From an asset protection perspective, Sarah retains some control, although John could potentially force a sale.

Option 3: Sarah helps John buy

A. Property issues

If Sarah’s gift or loan is insufficient to allow John to purchase the property, then John would need a mortgage. Given his student status, John is unlikely to obtain a mortgage, unless Sarah acts as guarantor.

If Sarah makes a loan, she should consider securing that loan with a legal charge, but if another mortgage is needed, that lender’s charge will have to take priority over Sarah’s charge.  

Once the property is purchased, John will be solely responsible for letting rooms, etc.

B. Tax / asset protection

IHT: Sarah’s gift is a potentially exempt transfer. Provided she survives seven years, there should be no IHT implications to the gift, and even if she does not, at least any increase in value of the property will be outside her estate.

Dying within seven years would use up some or all of Sarah’s nil rate band (“NRB”) allowance, currently £325,000, which is the amount available tax-free to her estate on her death. However, Sarah might obtain term assurance to cover any additional IHT caused by her early death.  

If Sarah lends funds to John, the value of the loan will remain in her estate for IHT purposes, but any increase in the value of the property will be outside her estate.  

CGT: The property is John’s main residence, so he should be able to claim PPR on any disposal, and may be able to claim lettings relief if appropriate.  

IT: John will have to pay IT on any rental income received.

A gift is potentially good from a tax planning perspective for Sarah, as it may remove the entire value of the property from her estate. A loan is less useful from a tax planning perspective. In either case, PPR / lettings relief should be available to John on a disposal.

However, John (as sole owner) will have control of the property. Therefore, Sarah may prefer a loan, allowing her to take a legal charge over the property. This would give her an element of control and greater protection if John gets into financial difficulty.  

Option 4: Using a trust to buy

A. Property issues

If Sarah puts money into a trust then the trust can either purchase the property, or make a loan to John. If the trust makes a loan, it should take security against the property, with a legal charge.

B. Tax / asset protection

IHT: Sarah can put up to £325,000 (the NRB threshold) into trust with no immediate IHT charge, provided she has made no other chargeable transfers (essentially, transfers not made to individuals) in the last seven years.

If she survives seven years, there are no IHT implications for her and, provided the value of the property in trust remains under the NRB threshold, then there should be no IHT charges on the trust’s assets while the trust is in existence.

If the value of the property is likely to increase faster than the NRB threshold, Sarah could put the purchase monies into trust, and the trustees lend funds to John to buy the property in his own name. This fixes the value in the trust, and avoids any IHT liabilities for the trustees.  

CGT: The trustees can claim PPR on a disposal provided the property is occupied by John as a beneficiary under the terms of the trust. If rooms are let there may be a restriction on the relief.

IT: The trustees will have to pay income tax on any rental income received. If the trust is a discretionary trust, this will be at the higher IT rate of 50 per cent, but if the income is paid to John he should be able to reclaim the difference between this and his lower rate of IT back from HM Revenue & Customs.

Again, this is potentially a good option from a tax planning perspective for Sarah, as it removes the value of the funds transferred into trust from her estate. PPR should still be available, but the letting of rooms may affect this. From an asset protection perspective, the trustees retain control of the property or funds lent. Sarah could (and probably would) be one of the trustees.

So, which option is best?

Depending on their circumstances, Sarah’s primary concern may be tax efficiency or control. In either case, suitable arrangements can be put in place but it is important that Sarah takes professional advice before deciding how to proceed, so matters can be structured in the best way for her and John.