My husband and I are coming up to retirement age and due to decades of house prices rising own a home that is worth just over £1million.
Unfortunately, that same house price inflation means that our daughter cannot afford to buy a family home in the town she grew up in.
We want to downsize to a smaller property, but instead of selling our family home we would prefer to gift it to our daughter while converting part of it and the garage into an annexe that we would live in, with a bedroom, living room, kitchen, bathroom and its own separate entrance.
The value of the house as it stands and our savings and investments built up over the years pushes us some way over the inheritance tax threshold, so doing this now would seem financially sensible.
Could we simply gift our home to her whilst continuing to live in part of the house and are there any tax implications we should be aware of? Via email
Inheritance tax brought in £5.3 billion for the government in the past year. A four per cent year-on-year rise.
Ed Magnus of This is Money replies: Passing on wealth to the next generation without incurring a considerable inheritance tax bill down the line is a dilemma faced by an increasing number of parents and grandparents in the UK.
With average house prices rising by 13.4 per cent in the past year alone, according to Nationwide, more people are finding themselves dragged over the threshold at which inheritance tax becomes due – largely due to the value of their property.
A special own home nil rate band for inheritance tax was introduced over recent years to tackle some of this issue.
But for a married couple who live in the more expensive parts of the country, their home’s value and their lifetime savings can still drag them over the £1million limit, above which 40 per cent tax is paid on their estate.
Inheritance tax receipts for April to May 2021 were £966million – £340million higher than the same period last year, due in part to an increase in the value of many people’s homes, according to HMRC figures.
HMRC revealed it collected £5.33billion from inheritance tax in the 2020-21 financial year, up from £5.12billion the year before.
The basics of inheritance tax
Inheritance tax is charged at 40 per cent above the tax-free allowances everyone has on their estate, known as nil rate bands.
|Tax year||Government inheritance tax receipts (£billion)|
|Source: HMRC/NFU Mutual|
Under current rules, if you give away the family home to direct descendants, a total of £500,000 each, or £1million combined, is the maximum value that a married couple or civil partners’ estate can reach before it starts being liable for the 40 per cent inheritance tax rate.
This is made up of the standard nil rate band of £325,000 per individual – of which any unused element can be passed on to a spouse or civil partner, effectively doubling their allowance to £650,000.
In addition, there is a £175,000 main residence nil rate band per individual (again potentially £350,000 for a married couple or civil partners) if the home passes to children or linear descendants on death.
In total, this means property-owning spouses can benefit from a £1million buffer before their estate incurs inheritance tax.
If the total value of an estate is worth £2 million or more, the additional main residence nil rate band will be tapered at £1 for every £2 over the £2 million threshold, meaning some higher value estates eventually lose the own home benefit altogether.
The other key inheritance tax basic to remember is the seven-year rule. This applies to gifts that are above set limits – for example, making more than £3,000 in gifts per year – and are known as potentially exempt transfers. Such a gift will only be free of inheritance tax if you survive more than seven years after making it.
|Years between gift and death||Tax paid|
|Less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
If someone dies between years three and seven of making a gift, inheritance tax on it tapers down on a sliding scale.
Under normal circumstances, were you to gift your property to your daughter there would be no inheritance tax to pay if you moved out and both lived elsewhere for another seven years.
If you wanted to continue living in your property after giving it away, then the rules change. If you lived there by yourselves, for example, you’d need to pay rent to your daughter at the market rate, pay the bills, and live for at least seven years to avoid the tax.
But you say that you only want to live in part of the house and this is where things become more complicated. For example, you would not have to pay full market rent on the whole property to your daughter if you only give away part of the house and she also lives at the property.
It is almost certainly worth you seeking specialist independent financial advice before acting.
What about care home fees?
A local authority may regard giving or selling a house cheaply to a child as ‘deliberate deprivation’ if you need care in future.
Lawyer Michael Culver, chairman of Solicitors for the Elderly, explains the pitfalls here.
He says: ‘There are also several risk factors to consider, such as if your children fall out with you, go bankrupt, get divorced – meaning their share of your property might have to be split with their partner – or die without proper provision within their wills.
‘You could find yourselves in the situation where the property is sold from under you.’
To explain the rules surrounding this, we spoke to Rachael Griffin, tax and financial planning expert at Quilter and Nigel May tax partner at MHA MacIntyre Hudson.
Can we gift our home to our daughter and live there?
Rachael Griffin replies: The short answer is yes, this is possible, but as you predicted there are some tax implications to navigate.
Generally, when you give away an asset during your lifetime and you live for seven years from the point of making the gift, it is not included in your estate when you pass away and will not be included in any inheritance tax calculations.
However, if you gift a house to a family member and continue to benefit from that property in some way, as you plan to here, it could have disastrous consequences for your daughter, and she could face a hefty 40 per cent inheritance tax charge.
What is the main inheritance tax risk?
Nigel May replies: If we assume that the house remains a single residence, the one thing that they must not do from an inheritance tax viewpoint is make an outright gift of the entire property.
The inheritance tax rules contain a provision called gifts with reservation of benefit.
This means that when you make a gift of an asset but retain the use of it, the gift is basically ineffective for inheritance tax purposes.
This means the normal seven-year rule for making gifts only runs from when you cease to have use of the property, not from the date of the gift.
This would mean that an outright gift would not create the inheritance tax savings they are looking for because of their ongoing use.
Since the tax-free allowance was raised to £325,000 in 2009, the amount of inheritance tax the Government pockets has more than doubled.
How can you gift only part of a home for IHT?
Nigel May replies: The good news is that there is an exception to this rule for cases where there is a gift of what is called an undivided interest in land.
An undivided interest in the land means neither you or your daughter will have a specific piece of the land but rather an interest in the entire property.
This means, for example, if the couple were to gift a 50 per cent interest in the property to their daughter and both the daughter and they were to occupy the property as a residence, the gifts with reservation rules would not apply and therefore the normal seven-year gift rule would apply.
If the couple were to survive seven years from the date of the gift, and the requirements of the undivided interest in land rule continue to apply, the value of the amount gifted will fall outside of their estate.
How else can you give away part of a home?
Rachael Griffin replies: If you want to continue to live in the property in the annexe then you must pay market rent to your daughter to ensure that the gift sits out of your estate for inheritance tax purposes.
But you must be confident in your daughter’s plans, because once you gift the home you will no longer have any rights to the property.
Nigel May replies: With larger properties it is sometimes possible to split the title by creating two separate properties and this can be an alternative way forward.
But the existence of a separate entrance may or may not denote that the new annexe is a separate property.
What if there is an outstanding mortgage?
Rachael Griffin replies: If you still have an outstanding mortgage, your daughter will have to pay stamp duty on the value of the outstanding loan.
However, there will be nothing to pay if you own the property outright.
Will the gift incur any capital gains tax?
Rachael Griffin replies: If your home has been your main residence for the entire time that you have owned it, you will be able to take advantage of principal private residence relief, which means your daughter can avoid paying any capital gains tax if you gift the property to her.
What else do you need to consider?
Nigel May replies: The major tax issue here is inheritance tax and ensuring that whatever is done does not fall within the gifts with reservation of benefit rule.
However, in this scenario, these can be dealt with either by splitting the title or by using the gifts of an undivided interest in land rule.
Rachael Griffin replies: Gifting your home is not a decision to be made lightly as the future is hard to predict and plans can change dramatically in a short space of time.
Owning a house brings a level of security that is hard to rival and while taking steps to reduce your inheritance tax exposure is prudent, you need to feel comfortable losing that asset completely as retaining any control will change your tax position and potentially expose your estate to inheritance tax.
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