The family home is likely to be your most valuable asset. Consequently, when looking to reduce inheritance tax, it may seem sensible to try and give your home away before you die. From a capital gains tax perspective, as long as the property has been your only or main residence throughout the time that you have owned it, giving it away, even to a connected person such as a son or a daughter, will not 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?
The GWR 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, being taken into account at its market value at the donor’s death. Consequently, giving away the home and continuing to live in it rent free is ineffective from an inheritance tax planning perspective.
The GWR 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 traps
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 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.
Ref: FA 1986, s. 102 – 102C and Sch. 20.