Watch out – being generous may cost you more than you expect…

Published on 9 November 2016

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You would think making a gift to pass on wealth to the next generation to try and save Inheritance Tax (IHT) on death is easy wouldn’t you? Unfortunately, that’s not always the case.

If you gift an asset but retain some benefit from it, then for IHT that is not an outright gift until the benefit ceases – until then, it is a ‘gift with reservation of benefit’. For example, if you give your house away and continue to live in it rent free, then the house stays in your estate.

Ignoring the questions of retention of benefit, be aware that a transfer of land or property is only legally valid if it is in writing, and may be evidenced by a ‘deed of trust’ or changing the entry at the land registry.

Parents often make loans to their children to help them buy their first house and then later let the children off repaying them. Unfortunately, this ‘waiver’ or gift of the loans has to be done in a special way using a ‘deed’ which has certain legal requirements to be effective – a simple verbal agreement or letter doesn’t work so the loans remain in your estate.

When making a cash-type payment, it may not be clear at the time if this is intended to be a loan or a gift – so it is worthwhile including a letter spelling this out.

Also, bear in mind that it is only for IHT that a gift with reservation of benefit is not effective – it may still be valid legally and for Capital Gains Tax (CGT) purposes. A gift of an asset liable to CGT incurs a potential CGT charge based on the difference between its cost and the market value at date of gift, even if no cash changes hands.

If the gift is of the family home which at that stage is exempt from CGT because of private residence relief, then no CGT will arise at that point. However, when the recipient sells the property, there is CGT due on his or her gain – assuming that he or she does not live in it as their home. If you have continued to live in it, then there is the worst of both worlds – there is a CGT charge which could have been avoided, and no IHT saving.

Pre-Owned Assets Tax (POAT) is another nasty tax charge that can hit the unwary. One situation where this can arise is where you sell your home and give the proceeds to your children so that they can then buy you a house to live in or perhaps build a ‘granny annex’. In this case, whilst you may have made a gift which is valid for IHT and other purposes, you will be liable to income tax on a notional market rent applicable to the property you use unless you pay a market rent which is then taxed on the children.

Apart from IHT saving, another common reason for gifting the family home in particular (though this might be any asset) is to try to lessen future care home fees by reducing wealth. However, this may well not be effective – local authorities can look at gifts and bring them into account if it was reasonable to assume they were made with this intention.

If you would like to know more about the tax pitfalls of giving, please speak with your usual Kreston Reeves adviser here or contact Nigel Moon here or on +44 (0)330 124 1399.

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