Passing on property: gifts, Inheritance Tax and trusts explained

A look at the pros and cons of giving away your property in order to reduce Inheritance Tax.

Why choose to gift property during your lifetime?

People choose to gift property for many reasons such as to estate plan, to see their families benefit during their lifetime rather than after they have passed away and to attempt to reduce Inheritance Tax (IHT).

People gift all sorts of assets including money, valuable items and often their homes.

Estate planning is becoming an increasingly common concern as house prices increase, pushing up the total value of people’s net wealth.

For most people, their home is their most valuable asset and therefore most likely to push them over the IHT threshold

Homeowners are permitted to give their property to their children at any time, even if they continue to live in it, however making such a gift is a very complicated process and often comes with many potential pitfalls.

Potentially Exempt Transfer (PET)

There is generally no IHT to pay if you gift your property to your children, move out of the property and survive for a further seven years, as such gifts count as a PET under the IHT rules.

After three years, the tax amount falls by 8% each year from the full rate of 40%, until the eighth year, after which the property is out of your estate for IHT purposes.

Should you wish to gift your property to your children and continue to live there you will need to:

• Pay rent to the new owner at the going rate (for similar local rental properties)
• Pay your share of the bills
• Live there for at least seven years

You do not have to pay rent to the new owners if both the following apply:

• You only give away part of your property
• The new owners also live at the property

Because gifts, as discussed above, are for no monetary consideration (no money is being paid), Stamp Duty is not generally payable.

Capital Gains Tax (CGT)

Gifting a property is a disposal for CGT purposes however CGT is only due on a property that hasn’t been a main residence for the whole time you have owned it.

If, for instance, the property being gifted has always been a buy-to-let, CGT is due for the whole period it has been owned by you.

CGT is paid on the increase in the property’s value since it was purchased, less expenses such as legal fees.

We've put together a guide to help you cut your CGT payments, but be warned that the tax could soon be changed as the Government looks to boost its coffers.

Income Tax

If you gift your property and then pay rent to your child/children so you can remain living there, the recipients of the rent (i.e. your child/children) will have to pay income tax on the money received.

Occupancy Agreements

If you gift your home to your children, you will no longer be the legal owner and you will have no legal right to remain resident in it.

An Occupancy Agreement can be put in place which would be signed by your children creating a right for you to reside in the house for the duration which they own it.

However, it is worth bearing in mind that should your children decide to sell the house there is nothing that you could do to prevent this and the Occupancy Agreement would then no longer have any relevance to the new owners of the property.

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Divorce and Bankruptcy

If you gift your home to your children and they subsequently get divorced, their spouse may have a claim to some of the value of the property which may result in the property having to be sold.

Similarly, if you gift your home to your children and they become bankrupt, the property may need to be sold in order to pay off their debts.

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Care Fees and Deliberate Deprivation of Assets

Should you or your spouse need to go into residential care, your Local Authority will carry out a financial assessment to determine how much money you should contribute to the costs of that care.

It is often the case that the value of your property will be included within this assessment and, on occasion, this can result in your property having to be sold to fund your ongoing care.

It is often the case, therefore, that people’s rationale for gifting property to their children is to avoid this happening.

However, care must be given in this regard as if the Local Authority deem that you have made the gift of your home in order to reduce the contribution level, it may seek to ignore the gift and include the property value within its assessment.

This occurs when the Local Authority considers the gift as a “deliberate deprivation of assets”. Many factors such as the timing of the gift are relevant here.

Read our guide on how to pay for the cost of care

Flexible Life Interest Trusts

Instead of transferring the family home outright, it is worth considering the alternatives, the primary one being a flexible life interest trust.

It is sometimes called a ‘family trust’.

‘A trust’ is a relationship which is recognised and enforceable in the courts and its details are contained in a trust deed.

Where there is a transfer of a property into the trust, the property becomes “the trust fund”. It is put into the names of persons called “the trustees”.

The trustees have certain powers over the handling of the trust fund for the benefit of the “beneficiaries” named in the trust deed.

The person who owns the property and is therefore transferring it may be a trustee themselves.

During your lifetime you can have the benefit of what is presently your home.

The home can be sold if you need to move with the proceeds being reinvested in another property for you. Alternatively, the proceeds can be invested to generate an income for you as necessary.

You do need to be aware that having a property in a trust is not the same as having it in your own name. 

The trustees can override your interest in the property (and any sale proceeds) if they have a good reason to do so which can be justified at law. A professional trustee can sometimes protect against these circumstances.

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Advantages of a trust

Why might a gift into a trust be better than making an outright gift of the home?

Financial obligations. Creating a trust can formally recognise the contribution which a family member or other person has made (directly or indirectly) to the property and/or to your lifestyle and care.

Knowing where the property will pass on your death. Having created the trust you will be able to tell family members if you wish, where it will go upon your death. It passes upon the terms of the trust which is already in motion when you die.

Avoidance of delays on death. A property in a trust can be sold without a Grant of Representation. The trustees can sign all the paperwork.

Passing on the burden of property ownership. You can pass the burden of owning a property on to the next generation using a trust.

Retention of a place to live. You can remain in the home so long as you wish unless circumstances change and the property must be sold to buy another suitable property or because you no longer need a home to live in.

Retention of income and discretionary capital payments. If the home is sold then you remain entitled to an income from it. 

This means that if needed funds will be available to supplement your income should you need to live elsewhere. You can also have payments of capital made to you at the discretion of the trustees.

The trustees do not own the property in the trust fund outright. For as long as you live the property is not theirs to deal with as they see fit and should not be available to their creditors or other claimants against, or factors affecting, their finances (for instance in the event of a trustees’ divorce or death).