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Inheritance Tax Tax Tips Articles & Advice Legal Updates Probate

Inheritance Tax: The Family Home

Estate Planning - The Family Home

For the majority of us the family home constitutes our major asset and in many cases, it is also the main cause of Inheritance Tax liabilities arising. To recap, one of the major stumbling blocks with regards to the home and Inheritance Tax is the 'Gifts with Reservation' loophole; where the owner of a property gifts it to someone else in an attempt to avoid it comprising part of their estate (thus no Inheritance Tax) but retains some kind of benefit from it, namely he/she still resides there despite it being held in someone else's name. The reservation as far as the Inland Revenue is concerned is a clear indication that the property was never a gift and therefore continues to be part of the person's estate for Inheritance Tax purposes. 

Another hefty blow is where the transferor of the asset continues to derive a benefit from it after 5th April 2005 there will - in ADDITION to retaining the Inheritance Tax burden - be an Income Tax charge on the deemed 'benefit-in-kind' arising.

However, despite these drawbacks, there are still a number of potential methods for mitigating and avoiding Inheritance Tax on the family home. Before looking at some planning techniques however, a brief overview of some legal aspects of property ownership is required.

Joint Property

Most couples own their property jointly, either as Joint Tenants or Tenants in Common. (A different legal title applies to property owned in Scotland but the tax saving principles are the same).

Upon death, with a joint tenancy that share of the property automatically passes to the surviving joint tenant (usually the widow or widower. The share cannot be gifted to transferred to anyone else by will or during life and to allow it to pass on death to the surviving joint tenant is bad Inheritance Tax planning!

In contrast, tenants in common have an independent share in the said property and they can leave their share to absolutely anyone. Thus when undertaking tax planning and the intention is to pass a share of the property to someone other than the joint owner it is necessary to ensure that the legal title is held as Tenants in Common.

Now we can turn to Planning Techniques. (The following techniques will assume that property is held as Tenants in Common).

Planning Techniques

Move Out, Give Away

If you can afford to so so and are willing to do it, you can simply move out of the house and then give it away. This will qualify as a Potentially Exempt Transfer which will not incur any Inheritance Tax at all if the transferor goes on to live for seven years after making the gift. In addition, providing you make the gift within 3 years of moving out the property will also be exempt from Capital Gains Tax under the Principle Residence rules. If you are prepared to do this you could then move into rented accommodation or buy a more modest property with a value that is below the Nil Rate Band.

This method will clearly not suit everyone, but it is an option at least.

Leave Half Share to Children

You could simply leave your half share to the children who will, after your death simply own the property jointly with the surviving owner.. Providing the house is not worth in excess of twice the Nil Rate Band, there will be no Inheritance Tax on it on your death. (NB: The current Nil Rate Band is £312,000).

This option will work fine assuming that all relations are amicable. You must be fairly comfortable that your children and THEIR spouses/partners if any will get along with your existing joint owner (your husband/wife for example) after you have gone. It might be worth pointing out from previous evidence and cases that this option, whilst appearing very simple and all parties assuring each other that things will be fine, may not in fact be the most effective; this simple route can cause difficulties and families in this situation have been known to come to blows - most metaphorically as well as literally!

So what was the point of suggesting it, I hear you thinking to your selves. Despite the above points, there IS away around these practical problems. The solution is as follows;

1. After inheriting a half share in the property, the children set up a Life Interest Trust with their surviving parent as both Trustee and Beneficiary and transfer their share into it.
2. The Provisions of the Trust are that the property reverts to the children as Settlors on the death of the surviving parent. When property reverts to a Settlor of a Trust, the transfer is exempt from Inheritance Tax tax.

Thus, the half share you left will fall back into the children's hands free from Inheritance Tax. Meanwhile, the deceased surviving owner will also leave their share to the children and THEIR Nil Rate Band will still be available to eliminate or at least substantially reduce any Inheritance Tax which may accrue.

Full Consideration Method

The 'Gifts with Reservation rules can be bypassed if, after giving the property to your children (or whoever else it may be) you then pay them a full commercial rent for continuing to life i the property. Payment of the rent would also help to further reduce your estate for Inheritance Tax purposes.

The major drawback to this method is the fact that your children would have to account for Income Tax on the rent which you are paying them and this is likely to render the method impractical in many cases.

Co-Ownership

This method is very popular with widows and widowers (or other single parents) who have mature single adult children. Quite simply, you just put the property into joint ownership with one of your children and then live together with them in the house. The transfer of a half share in the house is a Potentially Exempt Transfer providing the child is living there - it is the child's presence in the house which prevents it from being a Gift with Reservation' of benefit.

Shearing

The Inheritance Tax on the house can be reduced by dividing up the legal interests in the property in such a way that there is no 'Gift with Reservation'. The transferor must have owned the property for at least 7 years in order to utilize this method or if the property is owned jointly by a couple, each of the couple need to have owned their respective share for 7 years.

1. Create a 299 year lease over the property which becomes effective some years from now (i.e. in 10, 20, 30 years time).
2. Gift that lease to an Interest in Possession Trust with your children as the beneficiaries and you and you (and your partner if applicable) as trustees.

As the clock ticks away the years towards the time when the lease comes into effect, the value of your freehold interest in the property reduces and hopefully, if timed correctly, at the time of your death, your interest in the house will have minimal value and will easily be covered by the Nil Rate Band.

What happens if you or your spouse live too long though? If either you or your partner are fortunate to live long lives and see the lease come into effect, then, in order to avoid the 'Gifts with Reservation' rules, you could either start paying a commercial rent to your children (but see the note above) or alternatively, by that stage you will be happy to move into something smaller!!

NB: Revenue & Customs have advised that this method no longer works for leases created after 8th March 1999, and whilst there is disagreement amongst many professionals, this issue has yet to be tested by a Court case.
Additionally, the anniversary and exit charges introduced from 22nd March 2006 will apply to the value of the lease within such trusts.