There is a common misconception that in an attempt to limit the inheritance tax (IHT) due on an estate, the homeowner can transfer property into the names of their future beneficiaries whilst they are still alive and continue living there. However, this does not have the desired outcome and may instead increase the tax due on the estate.
Gift with a Reservation of Benefit
Reservation of benefit is when a party gifts an asset out of their estate, such as their property, but retains the benefit of it by still using or living in it. For inheritance tax purposes the asset will continue to be treated as part of the giftor’s estate, meaning the gift’s purpose fails.
Not only will there by no positive IHT outcomes, there may also be capitals gains tax (CGT) and stamp duty land tax (SDLT) complications to consider. CGT may become payable upon the transfer on the difference in value from when the property was purchased to the value of the property when the transfer is made. CGT rates differ depending on the income tax rates an individual pays, with those paying a higher rate of income tax paying 24% CGT on gains from residential property.
Dependent on circumstances there may also be SDLT to pay. This is particularly relevant if there is an outstanding mortgage on the property.
Options available
If a property has already been transferred, or if you wish to continue with a transfer, there are options available. If the giftor remains in the property and pays full market rent to the new owners then this is not reservation of benefit, but this must be a formal agreement with paperwork to show that the giftor is a tenant.
Alternatively, the giftor and giftee could cohabit in the property, but for this to not be viewed as reservation of benefit the giftee can only be gifted a share of the property and must cohabit with the giftor full time. This would be a potentially exempt transfer (PET) for inheritance tax purposes, meaning inheritance would be payable if the giftor died within 7 years of making the gift.
Will there be inheritance to pay on my estate?
The first £325,000 of an individual’s estate passes free of IHT. This is known as your nil rate band (NRB). If an individual is married or in a civil partnership and passes their estate to their surviving spouse or civil partner on the first death, then their NRBs amalgamate upon the second death (minus any chargeable gifts made within 7 years of their deaths), meaning couples who are married or in a civil partnership can potentially have a combined NRB of £650,000.
To be able to access the residential nil rate band (RNRB) you must:
- Have owned a property worth at least £175,000 as a sole purchaser ; or
- Have owned a property worth at least £325,000 with a spouse.
You do not necessarily still need to own the property, you can have downsized in the 7 years prior to your death and still be able to benefit from the RNRB.
Additionally, either your children or grandchildren must be inheriting the property, and they must be old enough under the terms of your Will to claim their inheritance.
Therefore, individuals who own property which they are passing down to a lineal descendant may be able to pass the first £500,000 of their estate inheritance tax free, and for a couple this may be the first £1,000,000. This is, however, dependent on whether any chargeable gifts or transfers were made in the 7 years preceding death and the IHT rules at the time. It is only the amount exceeding this which will be taxed at 40%, and due to tapering any estates worth over £2,000,000 have a reduced RNRB, meaning estates worth over £2,000,000 may lose some or all of the RNRB.
Before making any major decisions in relation to inheritance tax, it is paramount that you consider the size of your estate and seek professional advice from a solicitor and financial adviser regarding what estate planning measures can be put in place now.
If you are considering your options in relation to inheritance tax our Private Client team can help. Contact us today on privateclient@bussmurton.co.uk or 01892 510 222 to discuss the options that suit you best.
For bespoke advice on this or any other area of law, get in touch with the team now.
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