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Trust Properties Let to Settlor's Relatives-Issues

Should Trust Rental Profits/Losses be Segregated, What is a Commercial Rent + Trust Accruals Basis

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Please note the following from PIM2130 "Properties not let at a commercial rent":

https://www.gov.uk/hmrc-internal-manuals/property-income-manual/pim2130

Client settled two small residential houses into discretionary settlement about 6 years ago. The two properties are let to two close relatives of the client who have health & money issues.

For the first 5 tax years both properties made rental profits. However, for 2020/21 property A made a sizeable rental loss due to unavoidable repairs, whereas property B made a profit.

Client (one of the trustees) lets each relative (tenant) off a month or so's rent each year out of compassion/tenant hardship. But trustees are taxed on accruals basis only so trustees will be taxed on rents due, not rents received. What a pain! I cannot think of a way around this. Trustee acts on a whim each year and is not quick enough to formally waive rents in advance (how is this done without a solicitor).

It would be great if both properties' rental income and expenses could be pooled, but PIM2130 seems to preclude this. So not only are trustees going to be taxed on full rents due, they will not get any credit for the amount of expenses for property A in excess of its rent accrued. And that loss cannot be carried forward. (What a double pain!)

Client said that property A and B are let at 70% and of 75% of full market rent respectively.

But there are sound commercial reasons for having these two relatives as tenants as follows:.

1) Ordinarily, rents would cover all expenses,

2) By having close relatives as tenants the trustee is able to closely monitor what goes on in each property. Also, these close relatives know better than to trash the properties as would certain 3rd party tenants. As a consequence the trustee does not have to face the usual periodic bad tenant house cleaning etc. and other unwanted costs.

3) The trustee knows and trusts these tenants.

4) There is a fairly constant almost unbroken rental stream.

My only two suggestions would be:

A) For the trustee to insist on full rent receipts each year, but instead of "waiving" a month's rent each year, just gift each relative an sum roughly equal to a month or so's rent each year. After all, the trustee is fairly wealthy.

B) Get the timing of the big expenses right so that each property always produces a rental profit so that no expenses are wasted.

Does anyone feel I have missed any important issues, and is there a better way to deal with this situation.

By the way, it was the financial adviser who gave the advice to create this trust with the two rental properties let to relatives. Surely with the cash basis it might have been better to keep the properties in personal ownership, but that does not solve the problem of excess expenses. However, it may be that the ultimate IHT saving  is paramount here.

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By Tax Dragon
27th Jan 2022 07:26

Are these relatives beneficiaries of the trust? If so, there's no (tax) problem is there? And if not, perhaps they should be made such?*

But if not, the actual beneficiaries might have an actionable case against the trustee. If that trustee is acting in isolation, as you say, when the trustees are instead supposed to act as a body, I would imagine the case is against them personally. (But IANAL and this is all legal stuff.)

They must have taken legal advice though when setting up the trust and when getting the tenancy agreements in place between trustees and tenants. Well, if not must, should.

The trustee who is so generous with the trust cash could consider personally paying the outstanding rent on behalf of the relatives. That way, no actionable case, no tax issue, everyone is happy. (More money in the trust and I would guess it's a PET, not a CLT.)

*Obviously they should take advice before doing this. Could they continue to charge rents as tenants but at low rates due to tenants being beneficiaries? I don't see why not, but I repeat, IANAL. (And I don't give advice in here. At most, these are ideas. In reality, they probably barely pass as thoughts.)

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Replying to Tax Dragon:
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By Hugo Fair
27th Jan 2022 15:40

My immediate thoughts (not advice as you say) were pretty much identical to your final para (or rather the final one before the asterisked one).

The facts then align with the taxation and, more importantly, vice-versa.

Without knowing the numbers involved, it's even possible that the gifts covering a month's rent for each person each year would fall within the annual exemption for IHT or, if necessary, could utilise the 'regular payments from income-not-capital' for IHT purposes.

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paddle steamer
By DJKL
27th Jan 2022 09:11

Provision for specific bad debts may be your friend re the rents.

We account for ours (pship and two limiteds) on accruals basis, where I hit year end with arrears over six months old I tend to provide, now typing this maybe I ought not, maybe there are specific rules not permitting specific bad debt provisions within a property business, but I account for our rental business entities as if they were any other business entities.

One thing, if a month's rent not paid, and same sum received from tenant in a month when they do pay, how are you allocating receipts to rental invoices?

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Replying to DJKL:
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By Tax Dragon
27th Jan 2022 09:30

It's the line "The customer can only make a deduction where they have taken all reasonable steps to recover the debt" in PIM2072 that the OP is referencing.

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