Saving Inheritance Tax (IHT) on death by making a gift and surviving by seven years is standard tax planning sanctioned by statute. However, if you make a gift but ‘reserve a benefit’ in the property given, it will still be brought into charge on death, regardless of how long you survive.
So, if a parent gives their house to their children but continues to live there (without paying a market rent, regularly reviewed), the value of the house on death will be chargeable to IHT.
And there’s more bad news:
- When the children sell the property, they’ll pay Capital Gains Tax (CGT) on the increase in value from the date of the gift, not the date of death.
- The gift is likely to be regarded as a ‘deliberate deprivation of assets’ and the value still assessable in working out the contribution to care costs.
- The parent could find themselves thrown out of the home by their children - if not deliberately (though it does happen!) then as a result perhaps of a death, divorce or bankruptcy.
This isn’t the first blog I’ve written which advises ‘don’t give away the family home’ but I repeat the advice again on the back of an article by Harry Brennan in the Daily Telegraph on 13 November 2018: Taxman cashes in on £261m of 'gifts gone wrong': why gifting your home can backfire.
Harry Brennan writes: "The taxman has cashed in on £261m of "gifts gone wrong" [i.e. gifts with a reservation] in the last two years, as complex rules around inheritance and rising property prices saw hundreds of people losing out.
"Figures from HMRC obtained through freedom of information requests show £128m worth of gifted assets backfired in the 2017/18 tax year, while in the previous year £133m in gifted assets fell into the tax net, affecting over 840 estates in all."
My guess is that almost every gift falling foul of the reservation benefit rules was a gift of the family home with continued occupation.
Two questions beg to be asked are
- If it’s ‘common knowledge’ (or perhaps it’s not?) that a gift of the family home with continued occupation by the giver doesn’t work for IHT , why are so many such gifts being made?
- Why are solicitors accepting instructions to transfer a home from parent to children when they must know it’s ineffective for IHT planning (and likely ineffective in removing the house from ‘accessible capital’ in calculating the contribution to ‘care costs’?).
I think the answer to the first question lies, in part, with the UK’s obsession with home ownership and, in particular, with the aspirations of a post-war generation enjoying widespread home ownership .
To the numbers of persons owning their own home- in most cases, the first in their family’s history ever to do so - were added the many invited by the Thatcher government to buy their council house .
Out of the aspiration to own one’s home, there grew a second aspiration: to pass that property to the next generation.
Not only was the urge to join the ‘property owning democracy’ encouraged by government, special treatment of the value comprised in the ‘family home’ was given. Mortgage interest relief has long since disappeared but there remains:
- Relief from CGT on the sale of one’s home; and
- The new, additional, IHT residence nil rate bands, reducing the IHT bill on ‘modest’ estates containing a home left to the next generation.
Increasing numbers of children in their twenties and early thirties are still living at home. But few of the elderly house-owning generation now dying will leave middle aged children at home. Indeed, members of the generation that comprises those middle aged children (late born baby boomers and generation X) showed a unique tendency to abandon home turf and move to disparate and distant parts of the country (and, indeed, the world).
An argument that there’s a social need to avoid the family home being sold to meet an inheritance tax bill doesn’t really hold water – and the ability to pay IHT on the value of a house by instalments normally means that the tax payment can be managed without selling the house.
And finally, the assertion by many parents I meet who advise that ‘the children would be mortified to see the family home sold’ is, sadly, false. Experience shows that in almost every case – where Mum and Dad have both died - the children put their parents’ home on the market almost immediately.
The other issue exercising the generation of first-time homeowners is increasing longevity and the likelihood of their needing, at some stage, to move into a residential or nursing home.
Successive governments of every hue have made it clear that the country can’t afford to fund the accommodation costs of elderly persons with resources to pay for themselves (including a home no longer needed for family occupation) just to enable people to leave their house to their children (likely promptly to sell it).
- the desire to see the (empty) family home preserved; and
- a resentment that those seen to have made nothing of their financial lives getting their accommodation costs met
prompts many to try and take the house out of the ‘accessible pot’ when a calculation is to be made of the State’s contribution to residential/care home fees.
The ‘contribution to care’ motive may likely produce more unwise gifts of the home to the children than a mistaken belief that the gift is effective to mitigate IHT.
Assets given away with the intention of avoiding contribution to residential/nursing home costs will continue to be assessed as ‘notional capital’ when working out the contribution.
It’s hard to argue that the transfer of the property to children or into some sort of ‘asset protection trust’ was made for any reason other than as an attempt to avoid a contribution to residential/nursing home fees?
For one can’t sensibly argue that the principal motive for making the gift was IHT planning if it’s clearly a gift with a reservation. IHT planning with, indeed, a potential, immediate charge to ‘lifetime’ IHT if the gift is made into trust?
A gift of the family home will normally involve a Land Registry transfer. Most people ask solicitors to prepare the transfer and the subsequent registration of the new owners at the Land Registry.
Can we assume that some solicitors are simply accepting the instruction to prepare a transfer without warning the client of the many and obvious drawbacks of such a gift - including the impact of the reservation of benefit rule?
I fear we can and it bothers me. It’s long established that a solicitor can’t merely accept an instruction, but is professionally bound to advise the client on the legal, tax and financial implications of what’s proposed. While, conceivably, there may be scope for setting aside a gift where there’s misunderstanding/mistake as to its consequences or, perhaps, a potential claim against the solicitor for ‘failure to advise’, better, surely, simply to have been advised not to make the gift?
Finally, a reminder. Essentially, the only circumstances in which a gift of the family home by a parent with continued occupation will not fall foul of the Gift with a Reservation of Benefit are:
- A gift into the joint names of parent and adult child living at home; again, the Reservation of Benefit Rules will trap the gift if, at a later date, the adult child moves out (to get married perhaps);
- Payment by the parent of a full market rent for their continued occupation.
With careful advice and planning, this can be a remarkably effective way of shifting value from one generation to the next - especially if the older generation is income rich and the younger generation is income poor.
Careful arithmetic is needed and the knock-on effect on cashflow and the payment of income tax on the rent paid need to be factored in.
You need to be alert to the risk that the Gift with Reservation rules will kick in should the rent drop below market rate in the future – and schedule appropriate rent reviews taking specialist valuation advice as to the full market rent at each review.