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An unexpected catch to lending money

Lending money, say, to a family member is nothing unusual, neither is waiving the loan if they can’t repay it. The trouble is this won’t clear the debt for tax purposes, which could increase the IHT payable by your estate. How can you dodge this trap?

Family finances

Loans between family members are commonplace and it’s not that unusual for them to be written off. One example of this is where parents advance a loan to their son or daughter for a deposit on a home, which they later waive. When this happens the parents probably don’t give a thought to the inheritance tax (IHT) consequences, but they really should.

No IHT reduction

A loan is neutral for IHT purposes for both the borrow and lender. The lender hands over the cash, but then owns an asset of equal value, namely the right to repayment, while the borrower’s estate is boosted by the cash received, but now includes a debt of equal value. That’s pretty clear, but the picture is more cloudy if the lender decides to waive the loan.

The right paperwork

The terms of a loan are usually binding whether the arrangement is an oral or written one. HMRC accepts this position, but it won’t accept that a loan has been written off unless there is either:

  • a written deed (see below for what qualifies as a deed) confirming that the loan is not repayable; or
  • an oral or written agreement (which doesn’t count as a deed) to the same effect and the lender has received “valuable consideration” (see below) for agreeing to treat the debt as settled.

IHT payable on money you don’t have

If you don’t realise you own an asset it’s difficult to carry out proper IHT planning. And without a deed or an agreement plus valuable consideration, a loan still counts as an asset in your estate for IHT purposes even if you’ve agreed you don’t want your money back.

What’s valuable consideration?

The tax rules don’t say what “valuable consideration” is, but HMRC takes the view that it’s giving “money or money’s worth” for something. You could say where a borrower gave a lender £100 to waive a loan of £25,000, that they’ve given valuable consideration, but HMRC argues the £100 would not be “money’s worth” because the asset has greater value.

Tip: To put a loan waiver beyond doubt, and ensure that it’s effective for IHT purposes, use a written deed rather than a less formal document.

What’s a deed?

To be a valid deed of loan waiver, a document must state that it is a deed and include full details of its purpose. Plus, a signed and witnessed copy must be given to the borrower.

Tip: Although a deed is a legal document, you don’t have to pay a solicitor to draw one up. You can do it yourself, but to save you time we’ve done it for you. All you’ll need to add are the details and signatures.