James Bailey takes us through the potential minefield of inheritance tax (IHT) planning in respect of the family home.
The threshold at which IHT starts to be charged on a deceased person’s estate is £325,000 (for 2014/15), and there are many people who would escape any IHT on their estates if it were not for their home – their most valuable asset in many cases. What can be done to reduce the IHT payable?
Much ingenuity has gone into trying to avoid IHT on the family home, resulting in an increasingly complex net of anti-avoidance legislation. HMRC have two main weapons:
1. Gifts with reservation of benefit (GWROBs)
If you give an asset away, but you continue to ‘enjoy’ it to any significant extent, then for IHT purposes the gift is ignored so that the value of the asset still forms part of your estate for IHT. It is this rule that catches the otherwise obvious ploy of giving ownership of the home to your children – if you continue to live there, the value of the property still counts for IHT as if you still owned it.
2. Pre-owned asset tax (POAT)
This was introduced to catch schemes that claimed to have got round the GWROB rules. In broad terms, if you have the use of an asset you once owned, then unless it remains part of your estate for IHT because of the GWROB rules, you are charged to income tax on an annual amount broadly equivalent to the rental value.
So, what can still be done?
Co-ownership
There is an exception to the GWROB and POAT rules where a home owner gives a part share in the property to a person or persons (typically a child or children) who move into the property and share the running costs with the original owner. The part given away will no longer be part of the estate of the giver after seven years have passed, provided the sharing arrangement continues and each party bears their share of the running costs. If the child moves out before the owner’s death, however, the GWROB rules will kick in again and the planning will fail.
Full consideration
This is where you give the home away to your children and then pay them a full market rent to remain there. Provided the rent is at a genuine market rate, HMRC will accept there is no GWROB, and although the POAT still applies, it is reduced (probably to nil) by the amount of rent paid, provided the payment is under a legal obligation such as a lease.
The downside, of course, is that your child or children will be liable to income tax on the rent you pay them.
A variation of this is where you sell the property to the children for its full value and then pay rent to occupy it, which they can use to pay the interest on any loan they have used to fund the purchase.
There are two serious potential problems with both of these schemes:
- unless you have a lease for a term of years (itself an asset for the purposes of IHT), you will be dependent on your children’s goodwill and financial security for your security of tenure; or
- If the home is sold for any reason, the children will not qualify for the ‘main residence’ exemption from CGT.
Cash gift
This one may work, but it takes time. Give a cash gift to your child, which they use to buy a house. Wait seven years and then move in. No GWROB and no POAT. But can you afford to do it?
Planning Tip:
There is very little that you can do to avoid IHT on your family home, and all the strategies available have potentially serious downsides, in terms of your security of tenure and in terms of other taxes, such as CGT and income tax.
