Inheritance Tax Planning Strategies For The Home

Alan Pink looks at two comparatively risk-free strategies for reducing inheritance tax on the most important asset of most individuals.

A person’s home is probably the most difficult asset to plan for, as far as inheritance tax (IHT) is concerned. This is partly because, very often, the home is the most valuable asset in the estate and is also most ‘sensitive’ in the sense of being important to the owner from the point of view of non-financial/tax considerations. Secondly, the home is one of the most difficult assets to use without incurring the dreaded ‘GROB’ attack. 

GROB stands for ‘gifts with reservation of benefit’, and is legislation aimed at countering what might be the oldest capital tax planning trick in the book. In fact, it’s so old that it predates IHT, and even the previous version of IHT (which was called capital transfer tax). You have to go back to the days of estate duty to find the introduction of this rule, and its basic concept is very simple. 

Because IHT (and, before it, estate duty) could be avoided by making gifts during your life which reduced the value of your estate on death, the taxing authorities were obviously keen to prevent people giving things away in a painless fashion. The prime example of this, probably, is giving away your home whilst continuing to live there. If you do this, it is generally a gift with reservation of benefit, and the way the tax rules work is to treat the house as if it were still yours, even if, legally, you’ve transferred it into the name of your children (or whoever).

Various suggestions have been made as to ways of reducing the tax which the value of your home contributes to the total duty payable on death. Frankly, I don’t think much of most of them. 

Some of them used to work and now don’t; for example, the ‘Lady Ingram’ schemes under which you grant yourself a lease of the property and give away the freehold reversion. As the lease comes to its end, the value of your asset becomes less and less, and the value of the freehold (which you’ve given away) becomes more and more. This has been stopped. 

Then there were the ‘double trust’ schemes, which were much in vogue up to about 15 years ago. They lost their vogue rather suddenly when the government stamped on them from a great height (by introducing the ‘pre-owned assets’ income tax provisions). 

One scheme which still sort of works is the arrangement under which you give away your home to your children (or whoever), continue to live in the home, but do so on the basis of paying a full market rent to your children for the right to occupy your home. 

I’ve said this ‘sort of’ works because, generally speaking, this isn’t something which I would recommend. Why not? 

The fact is, there are a number of undesirable by-products of setting these arrangements in place. 

Firstly, you have to set aside enough of your income to pay the rent. If you have assets which give rise to your income (rather than your income being, say, pensions which are in excess of your requirements), there is an argument for saying that you might as well give away those assets, together with their income, as play around with the ownership of your home, especially in view of the further disadvantages of this arrangement. You are also creating an income tax charge, as likely as not, by paying rent to your children on which they will be taxable. On the other side of the coin, you won’t get any tax relief for the payments to them because you don’t get tax relief for paying rent to live in your own home.

There’s also an uncomfortable element of ‘knife edge’ about this planning. In principle, if you pay even £1 less in rent than HMRC consider to be the fair market value of your property, you’ve lost the whole benefit of the arrangement. It’s ‘all or nothing’. Finally, if your children aren’t living in the house with you, your saving in IHT (if you achieve it) is somewhat counterbalanced by the fact that your children will pay capital gains tax (CGT) when they sell the home after your death. Unlike you, they won’t be eligible for main residence exemption from CGT, and so will pay tax on the increase in value of the property between when you gave it to them and when they sell it. Given that these two dates need to be at least seven years apart in order to be wholly effective in saving IHT and given the way the property market tends to behave, this is not an inconsiderable problem. 

All right then, I can imagine the reader saying: ‘you’re telling us not to use these arrangements, and not simply to give our home to our children and continue to live there. What is there, clever clogs, that we actually can do?’

I am going to concentrate, then, on two particular different types of arrangements in what follows. This isn’t because I think there are only these two schemes that work; it’s just that these are arguably the most straightforward, where the circumstances are right. 

In summary, I am going to be introducing the following ideas:

1. equity release; and

2. the ‘live in beneficiary’ exception.

Under these arrangements, one approaches a specialist finance house (there are dozens of them on the internet – but much better to take advice from an independent financial adviser if you can find one who knows the subject) and raises capital on the value of the home. This gives you cash which you can give away, and hopefully survive seven years from doing so. The value of your home is reduced by the liability which you have saddled it with, being the share of any ultimate proceeds, on your death, which will go to the finance house under the arrangements. 

These equity release deals differ from normal mortgages in that they generally impose no obligation on you at all during your life. No interest or capital payments are required. Instead, the ‘interest’ reward enjoyed by the finance house will consist either in a rolled-up amount (if the equity release is more like a loan) or a share of the ultimate capital proceeds of the house if the arrangement is more in the nature of joint ownership. 

As a tax publication, of course, we have to make very clear that we are not advising anyone specifically to take out these arrangements, and we need to emphasise that proper advice should be taken on the financial and other merits and demerits of particular arrangements.

This is a relief from IHT which is explicitly written into the legislation (for reference, in FA 1986, s 102B) and, therefore, has what can be seen as the major advantage of being effectively government ‘approved’. 

Quite simply, where you give away a share in the home to someone else who is living there with you, the usual GROB rules don’t apply. There is one condition attached to this relief, which isn’t normally difficult to meet. This is that you, as the donor, should not receive any benefit, other than a negligible one, from the donee in any way connected with the gift. 

This relief has been used in many situations. One typical situation is where generation two moves in to look after generation one in their old age. No doubt complications arise where one out of a number of children is doing this, but nevertheless it shouldn’t be beyond the wit of man to devise a way of achieving fairness between the children (assuming this is the donor’s wish), whilst at the same time fitting in with the terms of the legislation. 

As with all gifts, of course, it’s necessary for these to take place at least seven years prior to death if the value given away is to be sheltered wholly from IHT.