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A.steve

A Hypothetical Regarding Inheritance...

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A discussion with a friend left me realising that I've almost no understanding of the implications of (secured) debt on inheritance.

The scenario we discussed can be summarised: A "Wealthy" individual has died and has left his estate to be divided among his 2 children. The estate comprises:

  • £1m in liquid assets (Cash; shares - etc.)
  • £4m in appraised value in real-estate [ 4 properties, say.]
  • £3m debt secured against the real-estate.

A naive assumption may be that each beneficiary will gain ~£1m... However, I think, the situation is more complicated. As one estate, the assets may be adequate collateral for cheap loans - but, this may not be the case if the portfolio is split... Another complication is that the will may not divide the liquid assets equally between the beneficiaries.

What is the process in such situations? Is it normal for the liquid assets to be used to repay debt ASAP (leaving little buffer to keep up repayments on the remaining debt)? Do lenders (typically) accept the increased risk of two smaller portfolios without increasing their risk premiums on loans? What happens if the properties are illiquid assets?

While this scenario is entirely fictitious, it strikes me that it is (probably) not very unusual. In these circumstances, does probate just take a "very long time"? Is it possible to determine which properties may be in such a situation?

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Assets in that case are £1m cash and £1m equity. Inheritance tax paid at 40% of the excess above the current threshold (was £325K but, moving to £500K since the equity will qualify). Double the allowance if the wife passed on here allowance unused.

In my experience (executor in a similar situation), the mortgage companies are pretty helpful. They basically want the mortgage to be paid until you can sell the house or transfer the house+mortgage to the beneficiaries (subject to their lending criteria on new business).

It does get tricky when the bank accounts need to be frozen but the mortgages still need to be paid. Even though the banks had been informed, they wrote repossession notices to the BTL tenants who then left pretty soon after.

For me, probate took round 8 months to sell up my relatives BTL's, sort out the tax forms and distribute the remainder of the estate.

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Assets in that case are £1m cash and £1m equity.

That's the naive analysis - it rests on a few assumptions:

  • The appraised value of the real-estate is an accurate reflection of an achievable market price.
  • The mortgages can be serviced until the real-estate can be sold... or,
  • Suitable new mortgages can be established to pay-down the existing debt.

My hunch is that, for that estate, perhaps... the £1m pays down £1m debt - leaving £2m in equity - and £2m in debt - the service of which represents a problem. The need to urgently resolve the situation drives down achievable market prices... and the achievable sale price on all the real-estate is only marginally higher than £2m - hence negligible inheritance.

Would it be possible for the cash to be inherited by one heir - and for the mortgages to go into default - surrendering all the real-estate to the mortgage lender?

If the valuation of the real estate was wildly inaccurate - for example, if it could only sell for £2.8m - would the heirs be obliged to pay down £200k from the liquid assets? What if it could only sell for £1.8m... surely it isn't possible to compel an heir to pay down a net debt, over the whole estate, in that circumstance?

Edited by A.steve

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That's the naive analysis - it rests on a few assumptions

For IHT, it' the analysis HMRC will apply until the real value of the houses is known via an open-market sale (not a low-value transfer to a beneficiary)

>leaving £2m in equity - and £2m in debt ....... hence negligible inheritance.

IHT is not payable on a % of (equity - debt), it is payable on a % of (assets - debt) which of course is %equity.

There would be £4m in assets - £2m debt = £2m equity. Pay 40% of ~£1.5-£1.7m. Ouch.

So, use the £1m of liquid assets to service the debt until the assets are sold.

If the executor pays out all the cash (£1m) to one beneficiary and lets the mortgage default, the mortgagor will repossess the properties and pay out the remaining balance. (£1m less costs/penalties). The total of £2m paid out is still subject to IHT but they have just wasted money on repossession costs and best price for the properties.

If the properties were in negative equity (£2.8m value vs £3m debt), then yes, the estate would have to cover the £200K from the £1M of liquid assets.

If the total estate value was less than the debt then the beneficiaries do not have to pay. You cannot force a debt onto someone like this.

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Inheritance tax paid at 40% of the excess above the current threshold (was £325K but, moving to £500K since the equity will qualify). Double the allowance if the wife passed on here allowance unused.

Could you expand on the bit in bold, please?

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Inheritance tax paid at 40% of the excess above the current threshold (was £325K but, moving to £500K since the equity will qualify). Double the allowance if the wife passed on here allowance unused.

Could you expand on the bit in bold, please?

Basic allowance is £325K but the equity in your family home up to £175K is IHT-free. Double the figures for a married couple since the IHT nil-rate band can be transferred. By the time the phase-in process is complete, the total IHT-free limit is £1M for a couple.

If you don't have housing equity, you don't get the extra £175K per person allowance. This may be an incentive for the oldies to hold onto their homes but I believe equity kept from a previous house sale qualifies.

There are a few more ifs and buts, but that is basically it. The extra £175K can only be passed to descendents (including adopted), not to siblings/friends.

These new limits help my kids when I pop off. If I inherit from my parents, I would be over the new limits so will have to plan for that e.g. bypass direct to my kids. They are more sensible than me anyway.

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Basic allowance is £325K but the equity in your family home up to £175K is IHT-free. Double the figures for a married couple since the IHT nil-rate band can be transferred. By the time the phase-in process is complete, the total IHT-free limit is £1M for a couple.

If you don't have housing equity, you don't get the extra £175K per person allowance. This may be an incentive for the oldies to hold onto their homes but I believe equity kept from a previous house sale qualifies.

There are a few more ifs and buts, but that is basically it. The extra £175K can only be passed to descendents (including adopted), not to siblings/friends.

These new limits help my kids when I pop off. If I inherit from my parents, I would be over the new limits so will have to plan for that e.g. bypass direct to my kids. They are more sensible than me anyway.

Thanks. Nothing there for single men with a lot of loot.

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A discussion with a friend left me realising that I've almost no understanding of the implications of (secured) debt on inheritance.

The scenario we discussed can be summarised: A "Wealthy" individual has died and has left his estate to be divided among his 2 children. The estate comprises:

  • £1m in liquid assets (Cash; shares - etc.)
  • £4m in appraised value in real-estate [ 4 properties, say.]
  • £3m debt secured against the real-estate.

[...]

While this scenario is entirely fictitious, it strikes me that it is (probably) not very unusual. In these circumstances, does probate just take a "very long time"? Is it possible to determine which properties may be in such a situation?

I've nothing valuable to add except I'm starting to feel a little like I'm taking crazy pills.

The OP reminded me that seemingly everyone in my age group (40-50) is talking about their inheritance, with many (esp. in the South East) mentioning *significant* figures like the above example.

Am I the only person in the UK with expectations of inheriting absolutely nothing, nada, zilch?

It sounds to me like everyone in my office, social group and forums are essentially going to 'win the lottery' in the next decade or so... perhaps that's why they're debt propelled and I'm living frugally...

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I've nothing valuable to add except I'm starting to feel a little like I'm taking crazy pills.

The OP reminded me that seemingly everyone in my age group (40-50) is talking about their inheritance, with many (esp. in the South East) mentioning *significant* figures like the above example.

Am I the only person in the UK with expectations of inheriting absolutely nothing, nada, zilch?

It sounds to me like everyone in my office, social group and forums are essentially going to 'win the lottery' in the next decade or so... perhaps that's why they're debt propelled and I'm living frugally...

Hey my literary namesake.

Zero expectation of any inheritance myself as parents have always been poor. I think some of those expecting a decent share of the loot will be disappointed as I can see a lot going on care (either their parents, or grandparents), or simply being spent.

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