Gary Rycroft Ask a Lawyer ‘Should we gift or loan money for daughter’s deposit?’

QOur daughter wants to borrow £ 65,000 to purchase her cottage. Can my wife and I each make a gift of £3,000 for the current tax year 2022- 23 and also the same amount retrospectively for 2021- 22? We do not wish to charge interest on the loan. Also, what is your advice on this with regards to the tax situation?

ANo matter how close you are to family members, it is always a good idea to think through and regulate these kinds of internal family financial transactions. No one with honest intentions should resent compiling formal and, if necessary, detailed legal documents to set out what has been agreed by the relevant parties, and why.

I say this not to drum up work for lawyers. On the contrary. Prevention is better than cure, and lawyers make far more money out of families who do not think through scenarios and who do not therefore put in place proper legal arrangements than those who do.

In other words, litigation is more likely – and indeed more difficult and expensive – when no thought at all is given to various “what if ” scenarios before family money changes hands.

Here you seem unsure if the capital you are to advance to your daughter is to be by way of loan or gift. So let me help you through various options and their respective implications.

A loan is a transaction where there is intention for the borrower to repay the capital and usually ( though you say not in this case) an agreed form of interest. Crucially this means the capital advanced remains an asset of the lender. If the lender dies it will remain part of the lender’s estate for inheritance tax purposes.

The capital will also therefore be a liability of the borrower if the borrower’s life heads off in an unexpected direction. Death, divorce and bankruptcy are the usual fears here.

The issue of whether to make a loan or gift is important if you are thinking of advancing capital to a child who has a partner. You do not say what your daughter’s situation is. But if she does have a partner, a loan to her means her partner would have no claim on the capital on separation, divorce, or death. But making a gift may mean your daughter’s partner would have a claim. A gift is a transfer of ownership away from you, the donor, to your daughter. A true gift is irrevocable, which means you may not ask for the gift back. If you do have the power to ask for it back, it is not a true gift.

You mention you and your wife each gifting £3,000 to your daughter this tax year and also retrospectively. This indicates you do seem to be leaning towards at least a part gift, rather than all the capital to be advanced as a loan.

The good news is that if you do want to make part of the proposed advance a gift there is an annual allowance for gifts, which are immediately exempt from IHT. This is £3,000 a year, which is where I assume you alighted on that figure. (On a side note, it is shocking that this figure of £3,000 has not increased since 1984).

In legal terms, the annual allowance is a sum that can be gifted without application of the usual rule that capital gifts remain relevant for IHT purposes for seven years from the date of the gift. The annual allowance immediately drops out of the donor’s estate.

As you allude to, you and your wife can each make gifts under the annual allowance. If you have not made a previous gift, you can gift twice the annual allowance. This equates to £ 6,000 for you and £6,000 for your wife, so £12,000 in total.

Much will come down to your level of trust and confidence in your children and/or their partners. I emphasise again that if your daughter becomes the true legal owner of any of the capital you advance to her for the purchase of her cottage, any partner may also have a claim on the capital upon separation, divorce or death.

Whatever you decide about how to treat the capital as a loan or gift, you should agree with your daughter and be clear about what you have decided and document it.

Any gift element can be recorded simply by a memorandum signed by you and recording the amount and date. This could be backed up by a copy of the bank transfer, bank statement or cheque. I suggest you keep a copy with your will.

Any loan may be evidenced and regulated by way of a simple “promissory note” under which the amount and date of the loan are recorded together with any repayment terms.

If the agreement is more complex – perhaps you may wish to take an agreed percentage or equitable share in the cottage – you could have a more detailed “deed of charge” or mortgage. You may say that the loan is repayable if your daughter divorces, which she may be very grateful for if that happens as it would restrict the shared capital to be split with her ex.

One last thought is that what starts life as a loan may later become a gift if you so choose. In that case the date of the gift (for the seven-year IHT rule) will be the date the loan is written off. As ever, do not forget to document any such decisions.

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Gary Rycroft is a solicitor at Joseph A Jones & Co. His column is published twice a month online.

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askalawyer@telegraph.co.uk