The inheritance tax “Nil Rate Band” has been frozen at £325,000 since 2009 and is set to stay at this level until 2028. The Nil Rate Band is, broadly speaking, the amount of your estate that can be passed to your beneficiaries free from inheritance tax.
It is increasingly the case that not only is the family home most people’s main asset in their estate, but that the value of their home is far greater than the Nil Rate Bands available to them.
It is no surprise then, that we are seeing all sorts of ways that individuals are trying to use their home to mitigate their potential inheritance tax liability.
In this two-part series, I am going to consider the following topics:
- Common pitfalls (see below)
- What you can do with the property (see separate article)
Common pitfalls
There are several ways that individuals try to mitigate their potential inheritance tax position. One of the big fears that we see is how or who will pay for care in the future or how can an estate be preserved for future generations.
Although the phrase goes, “fail to prepare, prepare to fail”, sometimes without good legal advice, we see clients getting ahead of themselves and causing more issues than they had anticipated.
Gifting property
We get enquiries about clients wanting to simply transfer the property out of their names and into their children’s, grandchildren’s, or friend’s name to take the property out of their estate and therefore reduce the amount of inheritance tax they may have to pay in the future.
The first problem with this idea is not considering the Gifts with Reservation of Benefit rules. This is HMRC’s attempt to stop people from “gifting” any assets whilst still continuing to receive a benefit from it.
A clear example would be a grandmother gifting her valuable painting to a grandchild, only for the painting to remain above the fireplace in the grandmother’s house. From HMRC’s perspective, the gift never took place because the grandmother is still able to enjoy the painting.
The same principle applies to the gifting of a main residence. Even if you formally transfer the title into another person’s name, if you never move out of the property and still live in your main residence, rent free, HMRC will deem this gift as never having taken place.
Moreover, people often overlook the implications on income tax and capital gains tax on both parties when transferring property. It is important to get advice about this to prevent an unexpected tax bill in the future.
In the past, there have been many schemes set up to try to get around the Gift with Reservation of Benefit rules. These were known as the “home loan”, “gift and loan”, “double trust” and “family debt” scheme. They were all variations of the same principle, and they operated in the following way.
An individual would set up two trusts. They would “sell” the property into the first trust and give themselves a right to reside in the property.
The “sale” would leave an outstanding loan due back to the second trust. The original owners of the property would not be beneficiaries of the second trust, but instead their children or grandchildren might be. The original owners would then remain living in the house rent free whilst repaying the loan into the second trust.
There was a recent ruling in April 2023 that struck down the use of these trusts and there is now clear guidance that these types of trusts fall within the gift with reservation of benefit rules.
If you have put your property into a trust, no matter how many years ago, it is worth getting professional advice about how that trust would stand today. Moreover, there may be income tax or capital gains tax implications for trying to unwind such schemes.
Care home fees
People are often so concerned with the value of the estate being used to pay for care fees without considering the full picture.
Firstly, we often have to remind clients that as they are our clients, their best interests come first to us. We need to ensure that clients still have enough to provide for themselves in the future.
However, more critically, if you start to give away your estate and then do not have enough money to pay for care, you may be criticised by the Local Authority for having deliberately deprived yourself of assets. The Local Authority will ask questions about gifts you’ve made; both about your intentions and the foreseeability of the consequences of your actions at the time of the gift.
For example, a person gets a diagnosis of dementia and then decides to gift their property away to a child in the hope that the value of the property will not be considered when calculating how much they have to contribute to their care.
This would likely be deemed to be a deliberate deprivation of assets and the original owner of the asset would still have to contribute to their care costs, even though they may have lost control of the asset.
Next, it is important to consider what happens in practical terms when property is gifted away to another person, but you still live in the property or hope to benefit from it. If a person gifts their property to a child and then that child unexpectedly passes away, the benefit of the property now passes under the will or intestacy of the child.
If that child is going through a divorce or bankruptcy then the property, that is in their name, may be taken off them in those proceedings.
The original owner has no protection and may have to move out of the home. Finally, if a parent’s relationship with their child breaks down, there is no legal recourse to go back on an informal promise.
Conclusion
Often, with careful consideration of someone’s individual position, these over-complicated schemes can be avoided and unexpected tax implications can be avoided.
Once people are informed about how much inheritance tax is likely to be paid (and the logistics of how this would be paid), compared to Capital Gains Tax or potential care fees, they are a lot less likely to make any rash decisions.
It is always sensible to get legal advice from a reputable source before making any changes to the ownership of your family home.
If you have any questions or would like any further information on the content of this article, please do not hesitate to contact our Private Client team. You can email [email protected] or call us on 01737 854 500 and one of our team will be happy to help.