More than 400 families fell foul of strict inheritance tax rules about gifting property last year and ended up paying an average of £125 million too much tax.
The 440 families were caught out by gifts with reservation of benefit rules, which lay down who pays inheritance tax (IHT) when the owner still lives in a home even though they have made a gift of the property to someone else.
For them, blundering into the tax maze rather than making a plan often broke the seven-year IHT rule that dilutes the tax bill if the owner dies within seven years of gifting the property.
However, there are several ways to minimise IHT bills without falling into the gifts with reservation of benefit.
Gifting property and inheritance tax rules
Gifts with reservation of benefit sound complicated but simply are when a homeowner gives property or share of a property to someone else but carries on treating the place as their own.
The most common pitfall is gifting your home to a relative while continuing to live there rent-free.
Another mistake is gifting a buy to let or holiday home while continuing to collect the rent.
The gift only becomes a potentially exempt transfer (PET) under IHT rules, providing the owner receives no benefit from the transfer.
HM Revenue & Customs checks IHT returns to ensure families pay the right amount of tax on PET’s and property transfers are carried out correctly.
The main point to consider about gifts with reservation of benefit is when ownership transfers, so the right to the enjoyment of the home switches with it. So transferring property into someone else’s name and staying there rent-free is not enough to remove a property from an estate to avoid IHT.
How to gift property without breaking IHT rules
Property owners can reduce their IHT bills in several ways without breaking tax rules:
- Renting – Owners can gift the property to friends or relatives while living there if they pay the same open-market rent as any other tenant. But, again, it’s an idea to lay out the arrangement in a tenancy agreement to avoid confusion.
- Equity release – Rather than give the property, unlock the cash tied up in bricks and mortar with equity release and then give the money away.
- Living together – Consider giving a share of your home to a relative who moves in with you.
- Downsizing – Selling the family home and moving somewhere smaller to release cash
Whichever way you decide to go, the seven-year rule for PET’s applies to any gift you make.
The PET seven-year rule for IHT
Gifts given away up to seven years before someone dies can still come with an IHT bill. How much depends on the value of the gift, who receives the benefit, and the date ownership switched.
- Possessions – like antiques, collections, jewellery or cars
- Homes, land or buildings
- Stocks and shares listed in London
- Unlisted shares owned for less than two years before death
The value of a gift is not necessarily what you received if you sold the property for less than market value.
If you sell a home at less than market value, the gift is the difference between what the buyer paid and what a buyer would pay on the open market.
Don’t forget spouses or civil partners do not pay IHT – only other beneficiaries
Calculating IHT under PET rules
No tax is due on gifts made seven years or more before death, unless held in trust.
If you die within seven years, taper relief applies according to this sliding scale instead of the 40 per cent standard rate:
|Years between gift and death||Rate of IHT on gift|
|1 to 3 years||40%|
|3 to 4 years||32%|
|4 to 5 years||24%|
|5 to 6 years||16%|
|6 to 7 years||8%|
|7 or more||0%|
Tax-free IHT gifts
IHT offers some opportunities to give money and possessions to loved ones without paying any tax.
Besides no IHT on gifts to charity or political parties, each taxpayer has some annual exemptions and allowances:
- Annual exemption – You can give away up to £3,000 each tax year to one person, or split the amount among several people. A couple can give £6,000 a year (£3,000 each) under the exemption. The exemption comes with a brought forward clause that means if you did not use your full exemption last year, you can add it to this year’s gifts.
HMRC gives this example; in the 2019-20 tax year, Mark gave £2,000 to his daughter Jane. If he died within seven years of the gift, this would use £2,000 of his annual exemption.
In the 2020-21 tax year, Mark gave £4,000 to his other daughter, Sarah. If Mark died within seven years of the gift, this would use his annual exemption of £3,000 plus the £1,000 of annual exemption left over from the previous tax year.
Even if Mark dies within seven years of giving these gifts, there’s no IHT to pay.
- Small gift allowance – Taxpayers can give £250 to as many people as they wish, providing no other IHT exemption or relief applies to a gift to the same person.
Birthday and Christmas gifts are not included in the allowance.
- Wedding gifts – Each year, taxpayers can make IHT-free gifts to someone getting married:
- £5,000 to a child
- £2,500 to a grandchild or great-grandchild
- £1,000 to anyone else
If you are gifting to the same person, combine the wedding allowance with any other IHT tax break except the small gift allowance. For example, you could give up to £8,000 to a child who is getting married by adding in your annual exemption as well.
- Living costs help – No limit applies to a taxpayer helping someone with their living costs, as long as you can afford the payments, and they come from your regular income.
Again, allowances and exemptions can combine – for example paying a son £100 a month to help with living costs, plus giving him £3,000 a year.
Keeping track of IHT gifts
Once you have passed on, tracking your gifts over the previous seven years or so is almost impossible. You should keep a record for the executor that includes:
- The nature and value of the gift with any supporting paperwork, like receipts and photos
- The date the gift was given
- Who received the gift and their relationship to you
- The allowance/exemption you intended to use