We get this question a lot. In typical lawyery fashion, the answer is ‘it depends’. The major ‘dependant’ factor is usually whether your children live with you or not. But in both cases, even if an IHT advantage might be secured, it is often a terrible idea in any event. I am pleased to set out below the various issues to consider if you are thinking about this type of planning.
Before getting into the nitty gritty, I would briefly note that this article assumes your children are all adults. Transferring a house to a minor is even more fraught with difficulty, which I don’t intend to dig down on here. I will also assume that you intend to continue to live in your property much as you have always done.
Finally, I have considered here the tax implications of gifting your home away. There are entirely separate issues regarding care fees and the deprivation of assets that also need to be considered before gifting away your home.
If your children don’t live with you
Inheritance Tax
The starting point for inheritance tax (IHT) is that any gift to an individual is a ‘potentially exempt transfer’ (PET). The value of a PET typically leaves your estate after 7 years.
However, if you retain a benefit in the asset you give away (i.e. you want to continue living in your house) this is known as a gift with a reservation of benefit (GWR). The value of a GWR never leaves your estate for IHT purposes.
But this does not mean the gift was ineffective, your children will become owners (or part-owners) of your house. Therefore, it will also be subject to IHT in their estates should they predecease you. You have now taken an asset subject to IHT once and turned it into one that is potentially subject twice.
It is possible to avoid the GWR provisions if you pay rent to your children for that part of the home they now own. However, HMRC look very closely at this and they will want to see that the home is professionally valued for rental on a yearly basis (you will need to keep these annual assessments) and you then settle the relevant rate. This means that rent will increase over time. That income will be subject to income tax in your children’s hands.
Capital Gains Tax
When you give an interest in your main residence away, this is a disposal for capital gains tax (CGT) purposes. Unless you have a particularly large home, this disposal is typically exempt from CGT due to private residence relief (PRR). However, that part you give away will lose that relief moving forward. So now, if you were to sell your home, your children may need to pay CGT on the disposal of their parts.
When you die, you also obtain a CGT uplift, so the beneficiaries of your estate will acquire your house at its value at your date of death. There can be no uplift though on any part you have given away during your lifetime.
Stamp Duty Land Tax (SDLT)
When you give an asset away for free, no SDLT will be paid by your children (as SDLT is only paid on ‘consideration’). However, your children will now be part owners of your house. Therefore, if they wish to move home in the future (or maybe purchase their first house etc), they will suddenly be subject to higher rates of SDLT which can be a considerable detriment to them. If they are a first-time buyer, this may be particularly detrimental as they will lose the favourable rate of SDLT that applies to first time buyers and may also lose the benefits of any help to buy ISAs or similar governmental schemes they may have been utilising.
Death, Divorce, Bankruptcy
Quite aside from the tax issues set out above, when you give an asset away you will no longer own it. If your child dies, divorces or becomes bankruptcy, this may force the sale of your house. Quite aside from that, if you happen to fall out with your children, they may force the sale of your house (sadly, this can and does happen). This loss of control, even if an IHT advantage might be obtained, is often enough to deter most people from this type of planning. That loss of control might manifest in other ways, for instance if you ever wanted to move in the future. Here you might need your children to consent and that is not always guaranteed.
There is some planning that can be done to mitigate some of these issues (e.g. your child updating their Will to protect your right to live in the home, post-nuptial agreements) but this all adds to the complication of this form of gifting, and none come without their own problems.
If your children do live with you
Inheritance Tax
In this case, there is an exemption to the GWR rules, provided you only give part of your home away to that co-habiting child (i.e. not all of it). This is a PET in the usual way, so will escape your estate after 7 years without the need to pay rent.
However, if that child were ever to move out (even if this were after 7 years), then the GWR rules would immediately kick in and you would need to start paying a market rent for the gift to remain effective for IHT.
Capital Gains Tax
The position is again slightly better here, as the part of the home you give away to your child would retain its PRR (being that child’s main residence). However, you still lose the uplift on death, and the child would lose the PRR (in part) if they were to move out in the future.
In respect of both SDLT and Death, Divorce and Bankruptcy the concerns above would continue to apply.
As can hopefully be seen from the above, despite this being a favoured form of advice you might receive from your mates down the pub, this type of planning is complex, often unsuitable, and can very easily create a worse tax (and life!) situation than you started with.
For that reason, I would strongly urge anyone considering this type of gift to take professional advice before proceeding. If you have any questions arising from this blog, please do not hesitate to contact any member of our Private Wealth and Taxation Team.