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