By Louise Misiewicz
Are you concerned about inheritance tax (IHT)?
Thinking about gifting your main home to your children?
You may want to transfer your main home from your estate to your children, but don’t want to pay Capital Gains Tax (CGT) or IHT. Ordinarily, there will be a CGT liability if you wish to transfer/sell your main residency because of the associated relief, which we discussed in a previous article here.
You may also wish to control of the asset so that the children do not make bad decisions that could erode the asset value, which may be managed via a Trust. Let’s imagine John that owns a home that he bought 20 years ago with the late Stephanie. He wishes to gift the home to James but feels that at 24 he lacks maturity and can make irrational decisions.
James is engaged to Mary but John has never warmed to her, and suspects that she is in the relationship for money rather than for her feelings for him. As such, he wishes to ensure that in the event of divorce the family home could be protected from Mary.
This level of control could not be exerted if the house was gifted directly to James.
What is a Trust?
A Trust is a mechanism in which a property is held by the trustees for the benefit of someone else. We talked about Discretionary Trusts in a previous article so we will not go into detail here. The one thing that this article did not suggest was how to manage the IHT liability.
Why use this strategy?
You would transfer your home into a Trust and back to your adult child for the following reasons:
- Provides an income for the adult child if they rented the property
- The level of tax is 20% of putting the asset into Trust in excess of £325,000, rather than 40% immediate IHT liability of transferring directly to the person
- Provided the child with a home
- Reduced the asset value of the parent for IHT purposes
Properties into trust and mortgages
It is very unlikely that the mortgage company will support the use of this tax avoidance strategy. As such, you will need to ensure that all mortgages for the property are paid off and remain unencumbered upon the transfer.
£325,000 IHT nil band rate
Each person is allowed to make gift of assets during their lifetime. There will be no tax paid on the transfer provided they do not pass away within 7 years. However, any transfers over and above the IHT nil band rate of £325,000 would be subject to an IHT charge of 20% if the asset is transferred into a Trust.
Let’s imagine that you wish to transfer a property into Trust that has a net value of £450,000. You would reduce this amount by the nil band rate of £325,000. This means that you have an excess transfer of £125,000 with an IHT charge of 20% being £25,000.
An additional IHT liability arises if a property is transferred into trust but the settlor dies within seven years. The amount of IHT due will be the value transferred at 40%.
However, the 40% is reduced by the following % amounts:
- 0% if dies within 0-3 years of transfer
- 20% if dies within 3-4 years of transfer
- 40% if dies within 4-5 years of transfer
- 60% if dies within 5-6 years of transfer
- 80% if dies within 6-7 years of transfer
You will get relief of any IHT paid as shown above upon the initial transfer. This ensures that you are not taxed twice on the same asset; in this instance the IHT payment of £25,000.
This assumes that no other transfer have been made. For the purpose of this article, we will ignore any previous transfers as though they did not take place. Please seek professional advice if you have made previous transfers in your lifetime.
IHT liabilities & Exit charges by transferring assets into trust and then onto the child
Once you decide to transfer the asset from the Trust to your child, you will need to consider exit charges. The exit charge is another form of tax over and above the 20% paid. The value of the asset is the net asset value of the property.
Let’s assume here that the nil band rate (on previous transfers) has been previously used up.
This is a little more complicated, so we will use an example:
- £450,000 asset value
- £325,000 less the nil band rate for IHT purposes
- £125,000 asset value chargeable to IHT on transfer into trust
- £25,000 IHT paid (£125,000 times by the 20% IHT rate)
We are now able to calculate the exit charge rate as follows:
- £25,000 IHT liability paid on transfer
- 5.56% being the notional tax paid of £25,000 divided by the asset value of £450,000
- 1.332% charge rate being 5.55% times by 30%, times by 32 being the number of complete quarters of the trust set up, divided by 40 (10 year anniversary of the trust being created)
- £6,000 being the exit charge of 1.332% times by the asset value of £450,000
As you can see that the total IHT liability on transferring an asset of £450,000 into trust is:
- £25,000 IHT on transferring the asset into Trust
- £6,000 IHT exit charge
The total tax on transferring a £450,000 asset is £31,000. This is just 6.89% of the asset value.
Please note that any additional transfers would be taxable without the £325,000 lifetime allowance as it has already been used up. There would be no IHT liabilities if the asset was worth less than the £325,000 IHT allowance, provided that no previous transfers had been made.
Gifts With Reservation – Anti-Avoidance Measures
HMRC have implemented anti-avoidance measures to prevent a parent transferring an asset to their children whilst benefiting from the use of it (living in the property). The parents’ intention was to gift the house and live on for seven years so that the asset is not considered as part of their estate.
IHT will be due on the full value of the house if a parent ‘gifts’ the property to their child, but continues to live in it without paying market rent.
To avoid this issue, the parent must:
Pay Market rent to the child (show transactions from their bank account) or
Move out of the property that they have gifted
Step by step guide to implementing this strategy
It is one thing to understand the theory but it is another to implement the above successfully. That is why we have created a step-by-step guide:
- Identify a property that has a value of less than £325,000 (which is below the IHT threshold)
- Anything above this value will be subject to IHT at 20% (if paid by the settlor)
- Transfer the property into a Trust (mortgage free) and calculate the IHT liability
- Transfer the property from the trust to the adult child and calculate the IHT exit charge
- Complete and submit the IHT100 form within 12 months of the said transfer
I just want to transfer it to my adult child without the need of a Trust
I wish you to keep in mind that the administration of putting the property into Trust is more work than it is to transfer the asset as a sale. It may be better to simply transfer the asset directly to the adult child, if your main home is less than £325,000. This is because there is no tax liability, as you will be using your IHT nil band rate even if you passed away within 7 years.
There would be no IHT liabilities irrespective of the gifts value if you passed away after 7 years. You do however need to consider potential Capital Gains Tax (CGT) liabilities.
How to engage with us
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