Personal injury trust asset swaps explained
Assets which are held within a personal injury trust (PI trust) are disregarded for means tested assessment purposes. The funds in the PI trust must have derived from any payment made in consequence of a personal injury. PI trusts are therefore widely used to hold personal injury compensation awards (PI awards) to benefit from this disregard, either to avoid losing current means tested entitlements, or as a planning tool so that protection will be provided in future should means testing become a consideration, for example, DWP means-tested benefits or local authority funding for care.
Any new residential property to be purchased out of a PI award should be held as an asset of the PI trust, i.e., purchased in the names of the trustees to hold on the terms of the trust for the injured person. This means the property itself will be protected from means testing, either now or in the future. Although a main residence would be disregarded for assessment purposes if held outside a PI trust whilst it is occupied as a residence, it could become an assessable asset in future, for example, if the injured person moved out but did not immediately sell the property and purchase a replacement or, went into care. A residence will be assessed after a 26-week disregard period from moving out. If a property is sold, then unless it is held in the PI trust, the proceeds of sale will be immediately subject to assessment. It is therefore important for all new property purchases to be made by the PI trust.
However, any property which is no longer the main residence, which was not purchased using the PI award and is not held in the PI trust, will be subject to assessment on sale or after 26 weeks from moving out.
"Although a main residence would be disregarded for assessment purposes if held outside a PI trust whilst it is occupied as a residence, it could become an assessable asset in future."
This is quite a common scenario. For example, someone may receive a PI award and need to purchase a new house as soon as possible to enable them to make the adaptations they need so that it is suitable for their requirements. They already own a home, but it is no longer suitable, and they cannot wait to sell it first, or the new house needs adapting before they can move in, so a simultaneous sale and purchase is not practical. Alternatively, they may wish to retain their former home and keep it as an investment. Unless they are able to transfer the former home to the PI trust, it will become subject to assessment from 26 weeks after moving out and any rental income received from the former property would also be assessed. On sale, the proceeds would be immediately assessed. This could mean all means tested entitlements would stop – or they would lose the ability to claim in future, due to the increased value of their capital.
The former property cannot be simply transferred to the PI trust by the owner because the property does not represent funds paid in consequence of a personal injury. However, an asset swap can be undertaken whereby a share of the new property, which is an existing asset of the PI trust, is swapped for the previous property, so that it becomes an asset of the PI trust before it is sold.
The process would be as follows:
1. A new property ‘A’ is purchased using PI award in PI trust. Existing home ‘B’ which was acquired before injury is retained
2. When ready to move out, former property B is then transferred to the PI trust in exchange for a share of new property A. For example:
- If new property A is bought for £1 million and property B is worth £250,000, transfer property B to PI trust in exchange for 25% of property A. Ownership would be:
- Property B: 100% PI trust
- Property A: 75% PI trust; 25% own name directly
- 25% of property A now held directly is not assessed as the main residence
3. If Property B is later sold or rented out, proceeds of sale or rental income pay to PI trust bank account and protected from assessment.
The property swap can also be completed if the former home was held jointly, for example by husband and wife, one of whom is the injured person with a PI trust. This would work as follows:
- Transfer previous property B to PI trust in exchange for 25% of new property A
- Ownership would then be:
- Property B: 100% PI trust
- Property A: 75% PI trust; 12.5% injured party; 12.5% spouse
Stamp Duty and Tax (SDLT) needs to be considered if there is more than one owner of the existing Property B. This is because the spouse / non-injured party is (in the above example) purchasing a 12.5% share of Property A from the PI trust in exchange for their 50% share of Property B, and the PI trust (i.e. the injured person for tax purposes) is purchasing 50% of Property B from the non-injured person in exchange for a 12.5% share of Property A. If Property B is worth £250,000 then there is no SDLT as a 50% share is worth £125,000, i.e., the SDLT rate is 0% between £0 and £125,000. However, if Property B was worth more than £250,000, then SDLT would be due at the applicable rates on the two transactions. The additional 3% rates for SDLT could also apply (where an interest in another residential property is held) but there is a specific exemption from the additional rates where there is a transfer of interests between spouses / civil partners. Other joint owners would be liable to the additional rate SDLT if the value of their share exceeded £40,000. In all cases, SDLT returns will still need to be filed even if there is no SDLT to pay where the values transferred exceed £40,000.
No SDLT arises if the former property was solely owned by the injured person as there will be no change in their beneficial ownership of the properties for tax purposes.
If another property other than the former main residence is exchanged, then Capital Gains Tax may need to be considered with respect to the share of the non-injured person.
Despite the potential for tax to be payable in some circumstances, it is often still worthwhile undertaking the property swap when comparing the tax cost with the potential total loss of means tested benefits if the former property was retained in personal ownership.
A property swap needs a PI trust as an entity to hold the disregarded property, but the swap exercise can still be available to those subject to a deputyship, if a PI trust can be created by the deputy to reflect the terms of the deputyship into which the property purchased using PI Funds can be transferred prior to then undertaking the swap exercise.
Where PI award have been used to redeem mortgages on existing properties held outside the PI trust, an equivalent share of the property can be assigned to the PI trust. This will protect that proportion of the property from assessment, and potentially a greater amount will be sheltered from assessment due to a discount to the valuation of the remaining share held personally. Again, SDLT should be considered where a co-owner is involved.
Important: Information in this article is provided by the author and Rathbones do not take responsibility for information contained.