For many people, their home is one of their most valuable assets, if not the most valuable. It is therefore an obvious candidate for lifetime estate planning.
The question therefore often comes up as to whether it is possible for parents to give their home to their children and continue living there. The answer to this question is yes, but with significant caveats if the gift is to be effective for tax purposes.
Inheritance tax
Generally speaking, if you make a gift to someone and then live for seven years afterwards, the gift is completely free of inheritance tax (IHT). However, one major exception to this is that, if you continue to benefit from the asset, you have given away, the value of the asset remains in your estate for IHT purposes. This makes them so-called ‘Gifts with Reservation of Benefit’ assets, meaning they have been gifted to another person but are still being used by the original owner. These assets are considered by the taxman to remain part of the donor’s estate for Inheritance Tax (IHT) purposes. Consequently, those who have been gifted the assets could face a considerable tax bill.
Taxpayers paid £125m in unnecessary tax through ‘gifts gone wrong’ in previous years*. These assets are considered by the taxman to remain part of the donor’s estate for Inheritance Tax (IHT) purposes. Consequently, those who have been gifted the assets could face a considerable tax bill. Given recent increases in property values, HMRC is likely to be examining IHT returns closely to ensure the right amount of tax has been paid and gifts of property, that have been made to mitigate IHT, have been executed properly.
There are, however, several ways in which homeowners can reduce the IHT bill on their estates without falling into the Gifts with Reservation of Benefit (GROB) trap and these include:
- Pay a full market rent for your occupation of the property – This should be properly negotiated between parents and children, with evidence that it is a fair market rent. Clearly, this comes with significant cash flow implications, and tax “leakage”, because the children will have to pay income tax on the rent they receive from their parents.
- Downsizing – selling the property, buying a smaller one and gifting the net proceeds to one’s children
- If one or more children live with their parents – There is an exception to the GROB rules where a share of a property is given, and the donor and donee share occupation. There is no statutory limit on the percentage of the property given, but HMRC will query it if the percentage is too large. It is also important that the parents continue to bear at least their fair share of the property’s running costs. It must also be borne in mind that if the child moves out then the whole value of the property falls back into the parents estate for IHT.
- Equity release – making use of a lifetime mortgage or equity release can enable owners to gift cash to their children. However, this should be approached with caution, as fees and interest payments will further reduce the inheritance that beneficiaries could otherwise receive
Capital gains tax & risk
Another thing to bear in mind is capital gains tax (CGT). A gift of a property is a disposal for CGT purposes. Gains on your main residence are generally fully relieved from CGT. However, if you have not lived in the property for the whole time, you have owned it, there is a risk that there may be some CGT to pay on the gift.
Once a house has been successfully gifted or signed over to the children, it then forms part of their estate and could be subject to life’s social issues. If children were to divorce, go bankrupt or predecease their partner or spouse – the value of the house could be used to pay their debts, pass to an in law who then wants to sell, included as part of a financial divorce settlement. There is also the reasoning that you are in fact ‘Kicking the can down the road’ inheritance tax wise as you could potentially be giving the children the same inheritance tax issues.
Summary
Hundreds of people are being unnecessarily caught out each year when passing assets along to the next generation. On average, they are throwing away more than a quarter of a million pounds each by falling into an avoidable trap. The complexity of the Inheritance Tax regime means it is very easy to make mistakes. Unfortunately, this can lead to beneficiaries facing hefty bills, so it is crucial to seek professional advice before including the family home in one’s estate planning and we are more then equipped to discuss such matters and discuss the best ways to gift assets.
*HMRC, year-end March 30th 2019.