Beware gifting properties – tax and other risks

The Telegraph has recently reported that almost 2,000 families have received inheritance tax bills collectively totalling over £600 million, where it has come to light (sadly only too late) that they have fallen foul of pitfalls that families may face where, typically, parents have gifted property to their children.

Given the ever increasing value tied up in people’s homes and a nil rate band frozen at £325,000 since 2009, many parents have sought to reduce their inheritance tax (IHT) burden by gifting their home or perhaps a second/holiday home to their children during their lifetime. The parent(s) may continue to live in or occupy the property(ies) under the mistaken belief that because they have given it away, this will mean the home is not subject to IHT on their deaths.

This news comes shortly after it was announced that HMRC collected record tax receipts during 2021/22.  HMRC collected £6.1 billion of IHT between April 2021 and March 2022, £0.7 billion higher than the same period the year before.

The background

Gifting wealth to children or grandchildren during lifetime is a very well-known, widely used and “legitimate” method of lifetime IHT planning. Often it is done by way of cash gifts, but where there is limited liquidity in their estate, many have sought to give illiquid assets (such as the family home) to their children in an attempt to reduce the IHT payable on their death.

Such a gift is a “potentially exempt” transfer. Provided the parent survives the gift by seven years, there will not be any IHT.  If the parent does not survive the gift by seven years, HMRC can clawback the IHT, with taper relief applying after three years.  Another crucial requirement, is that the parent must have given up their use and enjoyment of the asset completely. Failure to do so, may mean the gift is caught by the “gift with reservation of benefit” (GROB) rules.

The problems

Where a gift falls foul of the GROB rules, it is treated for IHT purposes as if the property still forms part of the parent’s estate (as well as the children’s estates) for IHT purposes.  This means that IHT at 40% will be applicable on the value of the property at the date of the parent’s death (and again on the children’s deaths) (subject to any available reliefs and exemptions).

To make matters worse, the gift may also inadvertently trigger other tax consequences. For capital gains tax (CGT) purposes, the children are deemed to have acquired the property at the market value at the date of the gift. If the property has grown in value since the gift, the children will be responsible for paying CGT on any gain when disposing of the property. As the parent (not the children) has continued occupying the property since the gift, the property may not qualify for principal private residence relief. The property will also not benefit from the CGT-uplift on the parent’s death.

Parents may also not consider the very important practical issues with giving away their property. By doing so, the parent will lose control of their home, meaning their home could be at risk should they subsequently fall out with their children, or if their children predeceased them or suffer any financial claims on divorce or bankruptcy.

A solution

It is possible for a parent to make an effective gift of a property, whilst continuing to reside there, if the parent pays full commercial market rent for their continued occupation.  The rent can be paid from the parent’s available income or capital.

Paying a full commercial market rent ensures that the gift does not fall foul of the GROB rules so that, after seven years have passed, the value of the property given away will be outside of the parent’s estate for IHT purposes.  If the property has increased in value, such growth will also be outside of the parent’s estate.  Furthermore, all sums paid by way of rent would immediately be free of IHT.  In suitable situations, this planning can be very efficient IHT planning.

There is no one solution that suits all circumstances. Depending on the facts, objectives and wishes of the family, it is possible that other reliefs or exemptions may apply and a more appropriate solution may be available. It is very important, therefore, that families take advice from suitably qualified advisers before making such gifts.

Edwin Coe’s Private Client team are highly experienced in advising on estate planning with property or other assets.  If you have any queries, or would like to discuss this topic, please contact Alison Broadberry, Jessica Brittain or another member of the Private Client team.

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