IHT and the Family Home
Ever since increases in residential property values began to outstrip the Inheritance Tax (IHT) nil rate band (currently £325,000 per person) how to mitigate the tax attributable to the family home has become a major challenge.
But it isn’t just about tax. All too often I see intended plans based on trust disintegrate into acrimony, unforeseen circumstances and impracticalities. The lesson is “don’t let the tax tail wag the dog”. Security and happiness must be the priorities.
So what options might sensibly be considered?
Full market rent
It is simply not feasible to make a gift of the family home, remain in occupation as before and expect to have removed the value of the property from the charge to IHT. The reason being, that within the legislation, there are “anti avoidance” provisions which provide that, where as asset is given away but a benefit continues to be derived from that asset, the value will still be subject to tax on death. These are known as the “gift with reservation of benefit” provisions.
But where full consideration is paid for the continuing benefit, then those provisions do not apply. So, if father makes an outright gift of his property to children, and pays a full market rent for the duration of his occupation, then, subject to surviving the gift by the requisite 7 year period, the value of the property will not be subject to tax on father’s death.
Now for most of us it seems a strange concept to pay rent to occupy a property we have spent our lives trying to buy. It needs to be remembered thought that the rent isn’t being paid to some remote third party landlord but our own family. Yes they will be liable to income tax on the rent received, and capital gains tax potentially on sale, but these may be comparatively insignificant in relation to the capital value of the property subject to IHT.
Rent needs to be paid for entire duration of occupation not just the 7 year period.
Such an arrangement is outside the scope of the “Pre owned asset” (POAT) income tax charge which was introduced as a deterrent to certain IHT mitigation schemes.
Gift to donee in joint occupation
The “gift with reservation of benefit” provisions outlined above are relaxed in circumstances where the recipient of the interest is in joint occupation with the owner.
So, if daughter lives with mother and mother makes a gift of an interest in the property to daughter, them mother does not need to pay a market rent for her continued occupation in order to perfect the gift. Subject to surviving 7 years, the value of the interest given away will not be subject to IHT on mother’s death.
The only caveat is that mother must not derive a benefit from the proportion given away. As long as daughter does not pay more than her share of the outgoings then no problem should arise.
Again, no POAT charge should arise.
What about Equity Release?
Instead of making a gift of the property itself some consider the alternative of using the property as a means of raising finance with which to fund outright, or structured, gifts.
This alternative requires careful analysis of the cost v benefit comparisons. Interest continues to accrue on the debt whilst outstanding. Again, the success of the arrangement depends upon surviving the gift by the requisite 7 year period and there is, therefore, an obvious danger in the event that death occurs within the 7 year period resulting in no saving of IHT but a charge to compound interest.
In circumstances of failing health funds raised against the property might, instead, be invested in assets which, after being held for just 2 years, qualify as business assets exempt from IHT.
Downsizing should be explored as an obvious alternative.
Gift of cash followed by purchase of property
The anti avoidance provisions do not contain any “tracing provisions” in relation to gifts of cash. Theoretically, therefore, if father makes a gift of cash to daughter and daughter subsequently uses that cash to purchase a property which father subsequently occupies, then the “reservation of benefit” rules are not applied. However this a strategy likely to attract the attention of HM Revenue.
It is also the case that, unless more than 7 years elapses between gift of cash and occupation of property, an income tax charge under the POAT provisions is likely to be incurred.
Lease carve out
In certain cases it might be appropriate to buy a “lease for life” for a capital sum as opposed to paying an ongoing market rent. A potential downside in relation to the latter is in the event that the rent should, at any time fall below the market rate and in which circumstances the reservation of benefit rules would be triggered.
The premium to be paid for the lease for life would need to be independently negotiated based on life expectancy. The recipient of the lease premium would incur an income tax charge on a proportion of the premium received. In addition, there is likely to be a charge to Stamp Duty Land Tax (SDLT) on the lease premium.
Contact an inheritance tax specialist
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- The nil rate band main residence Inheritance tax allowance: some queries answered
- Factsheet: The family home
- Factsheet: Gifting the family home – the risks and benefits
- Wealth, Health and Inheritance Briefing – view the latest edition and sign up for regular updates
- Family Wealth blog – for news and articles