Sarah Bradford examines some tax implications of gifting property to children.
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It may be considered desirable to gift property to your children, either to take it out of your estate for inheritance tax (IHT) purposes or possibly to protect the property from being used to fund care should you need it.
However, while the intention of the gift is straightforward, the tax implications are not – there are anti-avoidance rules to navigate.
Gifting the family home
A person’s home is likely to be the most valuable asset they own. If the value of a person’s estate is more than the available nil rate bands, reducing the value of the estate can, if done sufficiently in advance, reduce the IHT payable on their death.
Giving away the family home may achieve a sizeable reduction in a person’s estate. If this is on the cards, it is necessary to consider both IHT and capital gains tax (CGT), and particularly anti-avoidance rules that apply if the donor remains living in the home after they have gifted it to the children.
Inheritance tax considerations
At the time that the gift is made, there is no IHT to pay. The gift is a potentially exempt transfer and will remain free of inheritance tax as long as the donor lives for at least seven years from the date of the gift. If the donor dies at least three years after making the gift, the rate of tax payable on the gift where it is not covered by the nil rate band is reduced.
The nil rate band is £325,000 (for 2022/23). There is an additional nil rate band (the ‘residence nil rate band’) which applies where a main residence is left to a direct descendant, such as a child or a grandchild. This is set at £175,000 (for 2022/23) but is reduced where the value of the estate is more than £2 million by £1 for every £2 by which the value of the estate exceeds £2 million. Where a person survives their spouse or civil partner, their estate can benefit from any unused proportion of their spouse or civil partner’s nil rate bands.
If a person dies less than seven years after giving away their home to their children, the gift will be taken into account in valuing their estate at death. The nil rate band is applied to gifts in chronological order. If the home is the only or first lifetime gift, it will benefit from the nil rate band. This may not be advantageous, particularly if the deceased has survived at least three years since making the gift, so that some taper relief applies. The effect of this is that the nil rate band will shelter a gift which, if chargeable, would be taxed at less than 40% (and only at 8% if the donor had survived between six and seven years), leaving gifts on which IHT is payable at the full death rate of 40% in charge.
Capital gains tax
If a person gives their home to their children, there is a disposal for CGT purposes. As a child is a ‘connected person’, the disposal proceeds are deemed to be the market value at the date of the gift. However, as long as the property has been the donor’s only or main residence for the whole period of ownership (or whole period less the final nine months (or 36 months if they have gone into care)), the main residence exemption will apply to shelter the gain in full. If the full gain is not sheltered by the exemption, some CGT may be payable by the donor.
The children will acquire the property at its market value at the date of the gift. If they subsequently sell it, CGT will be payable if the property is not their only or main home.
If instead, the property had remained in the estate and passed to the children at death, they will acquire it at the market value at death.
Gifts with reservation
A person may wish to give their home away before they die so that it is taken out of their estate for IHT purposes (assuming they live at least seven years after making the gift). However, they may also wish to continue to live in it. Understandably, HMRC will not let a person ‘have their cake and eat it’ and there are anti-avoidance rules that apply where a person continues to benefit from an asset after they have given it away.
The ‘gifts with reservation of benefit’ rules effectively render the gift null and void for IHT purposes. Rather than being a potentially exempt transfer which falls out of charge if the donor survives seven years from the date of the gift, the property remains part of the donor’s death estate.
However, there are steps that can be taken to prevent the gifts with reservation rules from applying. If the intention is both to give the property away and to continue living in it, this can be achieved if the donor (say) gives their home to their child and rents it back from them. For this to be successful in preventing the gifts with reservations rules from biting, the donor must pay a market rent for the property. However, this assumes that the donor has sufficient income to do this. Further, the rent will be taxable in the hands of the recipient.
If a gift is made with a reservation of benefit and that benefit is lifted, the gift becomes a potentially exempt transfer at that point, and the clock starts its seven-year countdown. This situation may arise if, for example, the donor gives his or her home to a child and initially lives in it rent-free. If the donor then starts to pay the child a market rent for the property, the reservation of benefit is lifted, and the property becomes a potentially exempt transfer at the point at which the donor starts to pay a market rent.
Pre-owned assets
The ‘pre-owned assets’ rules are another set of anti-avoidance rules that apply where a person continues to benefit from an asset that they owned previously. They circumvent attempts to avoid the gifts with reservation of benefit rules by selling the home and giving away the proceeds, which are then (say) used by the recipient to buy another property in which the donor lives. In this scenario, the donor continues to benefit from a property they previously owned. The rules also bite if the donor gives away the property, the recipient sells it and buys another property in which the donor lives. The charge is not limited to land and property and can apply to other assets too.
Unlike the gifts with reservation rules, the gifted property does not remain part of the donor’s estate. Rather, the pre-owned asset rules impose an annual income tax charge on the donor.
The charge depends on the type of asset. In the case of land, it is based on the market value of the asset. The amount charged to tax is reduced by any rent actually paid. If the donor pays a market rent, they will not be subject to the pre-owned assets income tax charge. However, the recipient will be taxed on the rent they receive.
It will not always be preferable to pay market rent to avoid the pre-owned asset charge. For example, if the donor pays tax at a lower rate than the recipient of the gift, the tax bill will be lower under the pre-owned assets rules than if the recipient pays tax on the market rent. Also, the donor will only need to find the money for the tax and not for the full rent.
Practical tip
Care must be taken in making a lifetime gift of the family home in a bid to reduce the IHT on your estate. If you continue to live in the home, the gift will only achieve this aim if you pay a market rent for your occupation.
