For many clients one of their main assets is property, or properties. In a number of cases we have been asked if they can transfer this property to relatives before their death to mitigate Inheritance Tax (IHT). This has become an increasingly common concern as house prices continue to rise, pushing up the total value of many people’s estates over or further into the IHT threshold. Could giving away your house be a way to reduce your tax bill?
The first step for you to consider is whether to reduce the size of your estate through increased spending or gifting. Cash flow forecasting can be used to explore how much you could afford to gift but also if one or both of you were to require residential or nursing care at some point in the future. As with all estate planning this should be viewed holistically, with all the available solutions in mind. It may be that there are actions that can be taken to mitigate IHT without having to include your property.
It is important that you understand the risks of transferring property into your children’s name. By doing so you will no longer be the legal owner of the property. Therefore, if you decide that you wish to sell the property you first have to obtain the agreement of the new owner. Additionally, if they wish to sell the property, they will be able to do so without your permission.
If you decide that giving your property away is the simplest option then this is regarded as making a gift. Although there are some allowances for making gifts every year, the taxman is very particular about large gifts and has put in place a ‘seven-year rule’.
This rule means that if you make a gift of property you have to survive for seven years for the gift to fall completely outside of your taxable estate. This would commonly be known as a Potentially Exempt Transfer. If you die within seven years of making the gift then the value of the property falls back into your estate for IHT purposes and the person who received the gift would also be liable to a tax charge. The tax charge reduces depending on how long ago the gift had been made. The gift of the property would need to be outright to be effective, whether to an individual family member or a trust. This means giving up any right to receive rental income or a share in the proceeds. The gift should be evidenced in writing and the Land Registry entry would need to be changed.
You can continue to live in your property if you give it away but it will completely change the tax implications for you and the person you gift it to. If you give away a property but continue to live in it, this is likely to be a ‘gift with reservation’ and so ineffective from an IHT planning perspective, and may be seen by the local authority as a deliberate deprivation of assets from a long term care funding viewpoint too. This means that should the need for care arise shortly before or after making such a gift, this would potentially be seen as an attempt to avoid paying for care. In this scenario it’s likely that the property would be considered as part of your estate and used to fund your care fees. The property will also remain in your estate and be taxed on your death. You would have to pay rent at market rates, to fully prove that you have given away the property in its entirety and not benefit from it in any way.
Disposing of a second/investment property by means of a gift may give rise to a Capital Gains Tax (CGT) liability. Everyone has an annual tax free allowance (£11,700 in the 2018/19 year) but in excess of this the difference between the purchase price of the property and the market value at the date of the gift, less allowable costs of disposal, would be taxed. The tax rate can be as much as 28% depending on your marginal Income Tax rate. CGT is not applicable if you are giving away your main home, known as your ‘principle primary residence’.
An alternative to an outright gift of all of the property is to give away part of a property. You would then be a joint owner with whomever you chose to gift the property to. The part-gifted property would be treated for IHT purposes as above, but this would allow you to remain in the property and, in the scenario of an investment property, continue to receive some of the rental income. The downside is that the part of the property not gifted remains in your estate and subject to IHT. This could affect (reduce) the value of the property in that no one would want to buy part of a property thus making it virtually unsellable.
You may also want to consider the possibility that your children may have issues of their own, for example divorce. Your son or daughter’s soon-to-be ex-spouse would have a legitimate claim against their estate which would also include your/their property. If your son or daughter had an issue with bankruptcy the property would also form part of the estate. This would potentially be claimed by any creditors seeking to realise funds in order to repay monies owed to them.
Another option is equity release. Instead of gifting it away, you could take a mortgage out on the property. The cash generated could then be gifted. This would avoid any CGT charge as the property would be retained by you. The gift of cash would still potentially be liable for IHT if you died within seven years.
Equity release plans (also called lifetime mortgages or home income plans) are a way of releasing a cash sum against the value of your home with the debt typically repaid from the sale proceeds of the property upon moving into a care home or on death. Another equity release scheme is called a home reversion plan. This plan differs from the schemes above as you actively sell all or a percentage of your property to a home reversion company. These types of plans tend to lend a higher amount than the other equity release schemes, and can be very useful for people who have a commercial property as their main residence, such as a “bed & breakfast” or Guest House. Careful consideration should be given before committing to either of these schemes and specialist independent mortgage advice should be sought, as it is important to consider the costs and the degree of flexibility required in the future.
What must be remembered when gifting away your home or signing over the deeds to a loved one, is that this is not straightforward and you should weigh up the pros and cons before doing so. These are very complex areas and it would be best to take professional advice and speak to your adviser before making any decisions.
Paul Kemsley BSc (Hons), Dip CII
Tax treatment depends on individual circumstances and is subject to change.
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