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YOUR MONEY; Your money queries are answered by Trevor Clark, director of Rutherford Wilkinson Ltd, Chartered Financial Planners.

Q. My brother, who was single, died recently, leaving his estate to me, his only sibling, and my two sons. By far the biggest asset in his estate is his house, which was mortgaged.

I also stand to benefit from a life assurance policy my brother had written in trust for me, which he intended to be used to repay the mortgage on his property.

However, a friend has told me that, due to a change in legislation, if I use the proceeds of the life assurance to repay the mortgage then that mortgage debt cannot be deducted from the value of my brother's estate and, thus, I face the prospect of having to pay a significant inheritance tax bill? FIRST, I am sorry to hear of your loss.

The Finance Act 2013 introduced new limitations on the deductibility of certain debts. The provisions primarily were intended to counter tax avoidance schemes but have, inadvertently, affected "ordinary" people including those who have written into trust life assurance/ mortgage protection policies intended to repay a debt upon their death.

Before the introduction of the Act, debts such as a mortgage could be deducted from the value of a property when calculating the value of a deceased's estate for the purpose of assessing the amount of inheritance tax ("IHT") due on that estate, thus reducing the value of the estate and the amount of IHT payable.

However, the changes introduced by the Act mean that a mortgage can only be deducted from the value of an estate if the debt is repaid from the estate of the deceased.

A life assurance policy/mortgage protection that has been written in trust is outwith the deceased's estate and if the property is passed to the next generation still encumbered by the mortgage, which is subsequently repaid using the proceeds of the life assurance/mortgage protection policy, the debt would not have been repaid out of the estate and therefore is not deductible for the purpose of valuing the deceased's estate.

Consequently, those beneficiaries of people who have written such a policy in trust (and whose estates do not have sufficient funds with which to repay a mortgage) may now face an increased IHT liability.

HMRC is aware of this apparent unintended consequence and has issued draft guidance which it is anticipated will be added to HMRC's IHT Manual.

This guidance states that if the executors borrow money to repay the original mortgage, so that the beneficiaries receive the property encumbered with the new debt, HMRC will consider the original money to have been repaid from the estate.

Furthermore, the executors are able to take such a loan from the beneficiaries (for example, the beneficiaries could use the proceeds of the life assurance policy to advance a loan to the executors).

Provided that the correct procedures are followed, you may still be able to benefit from the tax-efficiency of your brother having written his life assurance policy in trust and be able to deduct the value of his outstanding mortgage from the value of his estate.

I recommend that you seek advice from a solicitor who specialises in estates to ensure that you follow the correct procedures and administer your brother's estate in a tax-effi-cient manner.
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Title Annotation:Business
Publication:The Journal (Newcastle, England)
Date:Nov 15, 2013
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