Buyer Beware - Gift with Reservation of Benefit Rules

2nd March 2020 Wills, Trusts & Estate Planning

As it is becoming increasingly difficult to get on to the property market, we have seen a rise in parents gifting their children properties or providing cash gifts for children purchasing a property. But what consequences does this have on the parents’ estate from an inheritance tax (IHT) point of view?

People tend to be familiar with the standard IHT planning of gifting away assets and surviving 7 years for them to be outside your estate for IHT purposes, but people appear to be less familiar with the ‘gift with reservation of benefit’ trap.

Gift with Reservation of Benefit Rules

If you make a gift but ‘reserve a benefit’ in the property given, it will still be treated as being part of your estate for IHT purposes upon your death, regardless of how long you survive from the gift.

So, if a parent gifts their house to their children but continues to live there, the value of the house on the parents’ deaths will be chargeable to IHT.

Likewise, if a parent buys a house jointly with their child (with the parent funding the purchase), and the parent takes up sole occupation of the property, there will be a gift with a reservation of benefit in the child’s 50% share. This will mean the whole property will form part of the parent’s estate for IHT purposes on death.

It is possible to pay rent to prevent a gift with a reservation of benefit arising. However, the rent must be full market rent and must be regularly reviewed. This is often closely scrutinised by HM Revenue & Customs upon a death. In addition, if an individual begins to pay rent, the property is not automatically excluded by the payment of rent and the 7 years rule also comes into play. 

Foreign properties

To the surprise of some, the rules regarding a gift with reservation of benefit also apply to properties abroad.

For instance, if a (UK domiciled) parent purchases a property in Spain in their child’s name but continues to benefit by regularly going on holiday and residing there, without paying a market rent, the whole value of the property will be chargeable to IHT on the parent’s death. In addition, the value of the property will be in the child’s estate for IHT purposes, potentially resulting in two charges to IHT. 

Pre-Owned Asset Income Tax Charge

There is also a problem if a parent makes a gift of cash towards the purchase of a property, which they then benefit from. Although the property may not be in their name nor ever have been in their name, there could be tax consequences as a result of this arrangement.

The ‘pre-owned asset tax’ (POAT) applies where an individual removes an asset from their estate for IHT purposes and continues to enjoy a benefit from it, but the gift with reservation provisions do not apply. Income tax is charged on the benefit the donor receives from the continuing use of the asset.

For example, parents sell a property and give the cash proceeds to their son. He uses the cash to buy a new property, with a granny annexe, which he occupies with his family. Almost immediately, the parents move into the granny annexe. This will result in POAT charges because, as the gift was of cash, the gift with reservation of benefit rules cannot apply.

If an individual has not been paying POAT there could be potentially back tax, interest and penalties to pay which can often be a shock discovery on the parent’s death.

Conclusion

The inheritance tax rules can be complex and if you are not aware of the specifics you could find yourself in a difficult situation, either in lifetime or on death.

Before embarking on any lifetime planning it is important to first seek professional advice, to ensure you are aware of the different rules and how they interact. Should you require any further information on inheritance tax and lifetime gifting please do not hesitate to contact a member of our team.

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Lucy Fowler is an Associate Solicitor located in Manchesterin our Wills, Trusts and Estate Planning department

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