Today there are over 11 million people in the UK aged over 65, and nearly 80% own their own home.
If you are of this generation, you might be thinking about passing assets to the younger generation in the most tax efficient manner or, perhaps, to avoid creditors or nursing home fees. The media regularly makes references to trusts as useful tax planning vehicles and, naturally, the family home may seem like a good place to start.
Unfortunately, giving away the family home (whether outright or into trust) tends to be a pretty bad idea for a number of reasons…
Don’t do it?
- If you continue living in the property after giving it away, inheritance tax (IHT) may nevertheless continue to apply to the property at 40% on your death under the 'reservation of benefit' rules.
- The only way to avoid a reservation of benefit is to pay a full market rent for living in the property. This may cause cash-flow problems and the full market rent needs to be reviewed every 2-3 years. If the rent paid falls below market value, the reservation of benefit rules will kick in. In addition, if rent is paid, whoever now owns the property (an individual, or trustees) will be liable to income tax on that rental income. Effectively there is a double tax; you will have paid tax on your own funds, and then the new owner of the property will pay tax again.
- From a capital gains tax (CGT) perspective, you will lose ‘principal private residence’ relief, which provides that no CGT is payable on a sale or other disposal of the property. If you give the property to a trust of which you are a beneficiary, the reservation of benefit will still apply for IHT purposes but the CGT ‘principal private residence’ exemption will be preserved.
- Generally (excluding the reservation of benefit rules), if you give a property to an individual, there will be no IHT to pay provided you survive the date of the gift by seven years. If, however, you transfer the property into a trust, there will be an immediate charge to IHT at 20% of the value of the property (subject to any nil rate band, up to a maximum of £325,000 per person, or £650,000 per married couple if the property is jointly owned).
- If the property is transferred into a trust, there will be on-going IHT charges every ten years, based on the value of the trust fund at that time, at a maximum rate of 6%.
- If the property is transferred into a trust, and the property (or proceeds arising from a sale of the property) is subsequently distributed to any of the beneficiaries, there will be a charge to IHT of up to 6% of the amount distributed.
- Ordinarily, if you own a property in your own name, your estate will benefit from an ‘uplift’ for CGT purposes so that any gain on the property before your death is effectively wiped out. If, however, you transfer the property to an individual or to a trust, this ‘uplift’ will no longer apply; CGT will be payable on a future sale, based on the increase in value since the date of your gift.
- It is sometimes thought that giving away property will take it out of the calculation of the contribution to the costs of care. However, if you give away assets and subsequently move into a nursing home, it is almost certain that the gifted property will be treated as “notional” capital which still belongs to you under the “deliberate deprivation” rules and still be taken into account.
- In addition, it is wrongly believed that giving the family home to another person or into trust will put it beyond the reach of creditors. The court will, however, set aside these gifts if:
- the gift is made within two years of bankruptcy;
- the gift is made within five years of insolvency; or
- the gift is made at any time with a 'material intention' of putting assets beyond the reach of creditors
10. Finally, there are occasionally horror stories of children who were given the family home by their parents, who then promptly sold it from under them (although more often a sale might be forced by the child’s death, divorce or bankruptcy).
Is there an alternative?
1. Downsize to a smaller property (or assisted living accommodation) and give away some of the sale proceeds left over
This is the most straightforward alternative. On a sale of the family home (assuming it is held in your personal name and you live in the property) there will be no CGT to pay. On a subsequent gift of part of the sale proceeds, there will be no tax consequences, provided you survive the date of the gift by seven years.
2. Borrow on security and give away some of the resulting funds
You may borrow against the property to generate excess cash. For IHT purposes this will reduce the value of the property on your death, because the borrowing will be deductible. However, it is important to ensure that the interest payable on the borrowing (especially rolled up interest on an 'equity release' loan) does not exceed the IHT saving.
3. Give a share in the house to a family member who lives in the property with you
If, say, an adult child lives with you, a gift into joint names with them should not fall within the reservation of benefit trap. But reservation of benefit will subsequently apply if, at a later date, they move out (to get married, say).