Editors note: Most of the info in this post pertains to those who live in the U.K.; Make sure you do your research for your local tax law before doing anything silly.
Buying a second home used to be exclusively for the rich. These days, buying a second home is more accessible to a broader cross-section of people.
One of the primary reasons many families buy a second home is to set it up as a future primary residence after retirement. Another common reason to own a second home is to create a family getaway in a favorite holiday location, either at home or abroad.
However, a little-known loophole in the tax laws could mean you have the opportunity to purchase a second home for your adult children to live in, while also avoiding capital gains tax.
Buying a Second Property for the Kids with No Capital Gains Tax
Rising property values and strict bank lending policies has made it more difficult for many people in their 20s and 30s to even consider the prospect of home ownership.
Yet, by setting up a formal written trust before you buy the property, you could purchase a second home for your kids to live in rent-free. You are named the trustee, and you name a child, or children, as the beneficiary for that trust.
For as long as the beneficiary resides in the property rent-free, you receive an exemption from capital gains tax on that property. You also don’t affect the capital gains tax status of your own primary residence.
To complete the purchase, you loan the trust the amount of deposit required for the purchase. The trust takes out the mortgage, although you’ll usually need to guarantee the mortgage under your own name, rather than as a trustee.
If your kids move out of the property and you decide to sell it, you’re given a window of 18 months in which to complete the sale without affecting your capital gains tax exemption.
Under certain conditions, you may also be able to take advantage of the tax benefits of owning a second property in trust for a property you’ve already purchased. For example, if you’ve already bought a property for your children to live in, you may be able to benefit from the capital gains tax relief under an ‘implied trust’ agreement.
It’s important to discuss the right type of trust with a good solicitor, as you have the option of creating a life interest trust or a discretionary trust. There is more information about trusts and taxes available on the Gov.co.uk website . You may also need to discuss the arrangement with a qualified tax accountant, to ensure your trust is compliant with tax laws and to check that you’re gaining the full tax advantages available to you.
Buying a Second Home with the Buy-To-Let Option
Of course, not every family can afford to purchase a home and let the kids live there completely rent free. In the event that you need your children to contribute towards rent payments to help keep up with the mortgage repayments, there are some ways to claim some tax relief.
If you intend to charge the kids rent to live in the property, speak to a solicitor and an accountant about the best structure to use for your individual situation. In some cases, buying the property in a trust may be better, but in other cases it may be more beneficial to put the home into your own name for tax purposes.
You’ll also find some helpful information about renting out your property and paying tax on the HMRC website.
If you’re not sure how much rent to charge the kids, contact Frank Innes and speak to one of the expert letting agents. They’ll help you work out a fair rent appraisal for your second home. From there, it’s up to you whether you charge the kids full rent, or offer them a discounted rate.
As a landlord, you can offset the interest costs from the second home’s mortgage against your tax bill. Even if you took out a mortgage over your own primary residence to fund the purchase of the second home, the tax department may still allow you to offset the interest costs.
The HMRC considers the purpose for which you borrowed the money, not the source from which it came from. As long as your remortgage was solely for investment purposes, you should be able to claim tax relief on the interest charges.
Of course, you will need to pay tax on any profits you make from earning rental income, but some of those profits can be written down by deducting some of the costs of owning the property. Letting agent’s fees, accountant’s fees, insurance premiums, utility bills, and maintenance costs may all be considered deductible expenses.
There are plenty of benefits for buying a second home. Just be sure you look at all your options carefully and understand the benefits and disadvantages before you jump in.