Inheritance tax planning can be a tricky area but, as a starting point, giving assets away to the next generation will often work. Generally, if the donor survives seven years from the date of the gift then the asset that has been gifted will be outside the scope of inheritance tax. Often, capital gains tax will be a big factor in any planning which involves gifting an asset because capital gains tax is usually based on an assumed market value receipt even if there is no consideration.
Just on the facts above, it would be a great idea for parents to gift their family home to their children and continue to live in it. Here, the analysis would be that there would be no capital gains tax on a disposal of the main home and then, as long as the parents survived seven years, there would be no inheritance tax charge. Clearly this would be too good to be true and so there are rules to stop this working. These rules are known as the gift with reservation of benefit (GWROB) rules and they have the general effect of treating an asset as remaining in a person’s estate when they retain a significant benefit from the asset (such as living in a house that they have given away). Therefore, this planning does not work, however similar planning can work with buy to let property.
Sarah is 80 and has assets of £2m, including the house that she lives in, which is worth £1m. Her other assets are two investment properties which are worth £500,000 each and which were recently purchased. She is keen to undertake some IHT planning but she cannot give away £1m because she relies on the income to live off. She is advised to give 99% of each property to her two children and then agree with them that she will still enjoy all of the income from the properties. The plan is that the value of 99% of the properties will be outside her IHT estate after seven years and yet she will still have the security of the income stream (that she will continue to be taxed on).
This works because the GWROB rules have a useful exception in section 102(b)(iii) of the Finance Act 1986 which relates to ‘buy to let’ properties. This legislation allows for a gift of an undivided (meaning not joint) share (meaning not the whole thing) of a rental property where the donor retains 100% of the rental income produced by the gifted property. This touches on another tax subject which is that joint owners of a property who are not spouses or civil partners can generally allocate the income of the property however they want.
Forbes Dawson view
This is clearly a useful IHT planning opportunity in the right circumstances, although the steps in the above example may not have made sense if the property stood at a significant gain because there would have been capital gains tax to pay. However, similar principles can be applied to cash. Here, cash would be given to the children to allow them to purchase a 99% share in an investment property along with the donor who would acquire a 1% share. Although this would introduce the question of whether a ‘pre-owned asset charge’ (an annual income tax charge that can apply if an asset has been successfully moved from an estate and yet still enjoyed by the donor) would apply, it is clear in that legislation that there needs to be occupation of any property by the person who has gifted the cash. This legislation should therefore not apply in the case of an investment property.
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