Inheritance Tax: Gifting Property to Your Child

You’ve spent a lifetime building up assets, particularly your family home, and understandably, you want to protect as much of that wealth as possible for your children. One common query that arises in this context revolves around the idea of reducing inheritance tax (IHT) by gifting part of your house to your child. But is that even possible? What are the rules? And importantly, are there any pitfalls you should be wary of? Let’s decode these complexities, step by step. In today’s Telegraph, a reader asks their expert for guidance – here’s a summary.

IHT and Property Gifts: The Basic Groundwork

HM Revenue & Customs (HMRC) has rules in place that allow parents to gift part of their home to a child who resides with them and will continue to do so. This could be a viable route for parents hoping to decrease the value of their estate for IHT purposes. However, things can get a bit complicated when trying to figure out the maximum proportion that you could potentially gift under this rule.

The family home, usually a significant asset, is a popular area for creative IHT planning. Yet, I caution you to be wary of schemes that seemingly offer a too-good-to-be-true solution; these could potentially invite scrutiny from HMRC. That’s why it’s crucial to understand the fundamentals of inheritance tax regulation concerning potentially exempt transfers (PETs) and gifts with a reservation of benefit (GWR).

A lifetime gift is a PET unless it is immediately exempt for some reason. These transfers usually become fully exempt after a seven-year period. The scenario of a parent gifting a house, or share of a house, to a child would classify as a PET.

Gifting but Retaining Benefit: Possible Pitfalls

GWR rules stipulate that a person cannot make a PET if they continue to benefit from the asset that’s gifted. This means that, generally speaking, you cannot gift all or part of a house to your child if you plan on continuing to reside in there. However, there’s a way to convince HMRC that GWR rules do not apply, and that’s by the parent paying a full market rent to the child. But given the current scenario of high rents, this might require substantial payments from the parent. Moreover, the child would have to declare this income and pay due taxes. This arrangement might be viable for some families, but for most, it’s a problematic approach.

Navigating the Exceptions: A Potential Solution

The regulations have an exception for families where an adult child is living with their parents. The Finance Act 1986 Section 102B provides this provision, known as an “old Hansard Exemption”. This term originates from a debate in Parliament, although it was never formally enacted into legislation.

Under this exception, a parent can gift a share of the house to a child, and then the house is owned jointly as “tenants in common”. Each party has distinct and defined ownership shares. The child and parents share the house as a communal household.

Understanding the Tenants in Common Arrangement

HMRC seems to prefer it when the parental share remains at least 25% of the total. It’s worth noting that whenever money is spent on the house, it has to be done in proportion to these shares.

This gifting from a parent to a child, creating tenants in common, is deemed a PET. Hence, the seven-year rule applies. The gift needs to provide the child with the right to occupy the whole house without restrictions to specific areas.

The parent gifting the property must retain an interest that allows them to reside in the entire property. In essence, this is a genuine house-sharing setup.

In order to convince HMRC of its legitimacy, the upkeep costs of the house (like insurance and utilities) need to be shared equally between all occupants. Future repair and maintenance obligations also need to be met according to the respective shares owned by the parents and the child.

Take note; this arrangement could be less convincing if the child has limited financial means to meet such expenditures, which include both everyday costs and future repairs. The child must also reside in the house, but not necessarily full-time.

Not Just Good Practice, but Essential Evidence

Despite sounding formal, it’s a good idea to have a written agreement outlining who will pay what in this kind of multi-generational living scheme. This serves as strong evidence for HMRC about the arrangement that was intended from the beginning, and how it has evolved.

Furthermore, these shared household arrangements must continue until the parent who made the gift passes away, or else any IHT mitigation will be lost.

If the arrangement does last until the parent’s death, an extra bonus is that HMRC agrees that up to a 10% discount for joint ownership can be applied when valuing a share of a house.

It’s a complex area that demands careful thought and clear understanding. Please ensure you seek professional advice tailored to your particular circumstances before embarking on any IHT measures, as each family’s situation is unique.