IHT: the basics
Inheritance tax (IHT) is levied on lifetime gifts (at 20%) and on death (at 40%).
Each individual is entitled to a “nil rate band” currently worth £325,000. What this means is that, for example, on death IHT at 40% is payable on the individual’s estate (ie his assets less liabilities) in excess of £325,000. Where one spouse leaves their whole estate to the other surviving spouse (an exempt inter-spouse transfer) no IHT is payable on the first death and on the death of the surviving spouse only the amount of the survivor’s estate in excess of £650,000 (ie two nil rate bands) is subject to IHT at 40%.
If therefore a couple jointly own their home worth say £750,000 (assume no mortgage outstanding) and the first spouse to die leaves their interest to the other spouse then on the death of the latter IHT of 40% of [£750,000 - £650,000] ie £40,000 is due.
Gifting the home
To avoid such an IHT charge many couples appear to believe that they can give their home away (typically to one or more of their children) yet continue living in it. It is true that the lifetime gift from parent to child qualifies as a PET (ie a potentially exempt transfer) and so long as the donor (ie the parent) survives at least 7 years no IHT arises on the gift. However, on death of the parent, despite no longer owning the home it continues to be treated as part of the parent’s estate and IHT is charged on it; this is because the lifetime gift is classified as a “gift with reservation”. In essence, although the home has been given to (say) the children the parents continue to occupy it and are regarded in a sense as still owning it for IHT purposes.
Where parents wish to continue to live in their home but reduce IHT on death one under-used option is for a share of the home to be given (say) to one of their children (or possibly more than one) following which both parents and child(ren) occupy the property together.
The gifted interest in the home qualifies as a PET and thus in principle falls outside of the donor’s estate so long as the donor survives for seven years. Furthermore, even though the parents continue to occupy the home the gift is not treated as a gift with reservation in which case the gifted share does not form part of the parents’ estate on death (and hence no IHT is charged on that share).
In practice a gift of 100% of the home is not acceptable to HMRC but a gift of no more than 50% appears acceptable; thus, parents would retain 50% and child(ren) would also own 50%.
It is important that the parents do not receive any benefit associated with the gift from the children who own the other 50% otherwise the gift with reservation provisions apply (and no IHT saving is achieved).
To prevent the parents from receiving any benefit from the children the running expenses of the property (ie heating, lighting, etc.) should be paid by both donor and donee re?ecting their respective usage (not re?ecting their respective ownership percentages). If, for example, 20% was gifted to one of the children (the parents retaining 80%) the expenses should be split one third each (not 40/40/20%).
There is, however, nothing to prevent the parents continuing to pay all the running expenses of the property and may be preferable (see below).
Outright sale compared
Another option often considered is an outright sale of the property for market value to the children followed by rent-free occupation by the parents (but not the children).
The main disadvantage of this option is that on a future sale of the property a capital gains tax (CGT) charge will arise as the children (who own the property) do not live in it; whereas the gift followed by joint occupation option discussed above precipitates no CGT on sale.
Although the co-ownership option is perhaps not suitable for some family situations, as children are finding it increasingly difficult to fund their own property purchase, and parents find it more difficult to fund household running costs, perhaps sharing offers an increasingly realistic option.
It may be sensible for the parents to continue to discharge all the running costs as this will also dissipate their estate for IHT purposes on death whilst at the same time benefitting the children.