For many, the family home will be the most valuable asset they own. Consequently, when exploring ways to reduce inheritance tax, it is common for people to try and gift their home to someone else within their family before they die. However, as with all types of tax planning, it is important to be aware of the pitfalls of choosing this route.
From a capital gains tax (CGT) perspective, if the property has been the only property you have owned or has been your main residence for the duration of owning it, gifting it to a connected person (even a son or daughter), won’t trigger a capital gains tax bill.
From an inheritance tax perspective, the gift would be a potentially exempt transfer (PET) and would fall out of charge if you survive for at least seven years from the date of the gift.
What could possibly go wrong?
Gifts with Reservation Rules
Problems will arise if, after giving away your home, you continue to live in it, as the gift may fall foul of the gifts with reservation (GWR) rules. These are anti-avoidance rules which combat attempts by donors to transfer assets outside of their estate while continuing to derive a benefit from the asset. The rules will apply, for example, if you transfer your home outside of your estate, but continue to live in it rent-free until you die.
For inheritance tax purposes, the rules effectively treat the gift as being null and void, and the asset remains part of the estate which will be taken into account upon the donor’s death at market value. Consequently, giving away the home and continuing to live in it rent free is ineffective from an inheritance tax planning perspective.
The GWR rules only render the gift ineffective for inheritance tax purposes – the capital gains tax position is unaffected and the gift remains valid. This means that where the home is given away prior to death and assuming it is not the donee’s only or main residence, the donee may incur a capital gains tax bill when the property is sold on any increase in value from the date of the gift.
Under the connected person rules, the children are deemed to have acquired the property at its market value at the date of the gift. The benefit of the tax-free uplift on death for capital gains tax purposes is lost without any compensatory inheritance tax savings.
One of the main drivers for giving away one’s home is to retain the asset within the family and to prevent it being sold to fund care costs. If this, rather than inheritance tax savings, are the reason for giving away the family home, again care should be taken as such a strategy may be viewed as deliberate deprivation of assets by HMRC and social services.
Avoiding the Gifts with Reservation Rules Pitfalls
The impact of the GWR rules can be avoided where the donor continues to occupy the property after giving it away if they pay a market rent for doing so. The gift will then count as a PET and will fall out of the estate if the donor survives at least seven years. Even if the donor dies before the seventh anniversary of the gift, there will be inheritance tax savings due to the operation of taper relief if the donor survives for at least three years from the date of the gift. However, on the flip side, the donee will need to declare the rental income and pay tax on it.
Another option is for the donor to gift a share in the property, rather than giving it away entirely, and for the donor and the donee both to live in the property together and to share living costs. This does not need to be full time, but there must be some shared living. The GWR rules will not apply if the donor is not receiving any benefit from the gift.
For further information about gifting your family home and the tax implications, get in touch. Simply call 0800 112 0880 or email [email protected] – a growing business needs more from their accountant.
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