The Christmas inheritance tax trap and how to avoid it

A bank transfer or a cheque might not seem like the most thoughtful gift to receive on Dec 25.

However, a financial gift this Christmas could be hugely appreciated by children or grandchildren who are planning a house purchase, struggling with the cost of living, or who simply want to treat themselves.

But you will need to be careful that an especially generous gift does not land you in trouble with HM Revenue and Customs. Sean McCann, of insurance firm NFU Mutual, said: “While tax may be the last thing on your mind when giving Christmas gifts, there are a few inheritance tax and capital gains tax traps to be aware of.”

There are strict rules about how much you can give before inheritance tax is due. Fall foul of these rules and your family could be in for a nasty shock when it comes to winding down your estate. Many people also forget that giving away an asset they already own – such as jewellery or a house – could incur a hefty capital gains tax bill.

HOW MUCH CAN I GIVE AWAY? A large enough gift could trigger an inheritance tax liability when you pass away, depending on the size of your estate and the gift itself.

Up to £3,000 a year is instantly tax free. If you did not use this allowance last year, then you can give away £6,000 by carrying forward the unused sum.

Alternatively, you could give sums of up to £250 to as many different people as you like. But some people – especially those with larger estates – may want to give away more than the tax-free allowances.

Shaun Moore, of the wealth manager Quilter, said: “Christmas can be a good time to make sizable gifts during your lifetime that not only reduce the size of your estate, but can also help give younger generations a leg up.”

To avoid inheritance tax completely, you must bring your estate below the taxfree threshold, otherwise there will be a 40pc charge on the excess.

This threshold is either £325,000, or £500,000 if you are passing on your main home to your children or other “direct descendants”.

You can give away much more than the annual allowance of £3,000 provided the gifts meet certain criteria. Unlimited sums become free from inheritance tax once you have outlived them by seven years.

You can also give away large sums without worrying about the seven year it away could trigger a capital gains tax bill. Basic-rate taxpayers pay capital gains tax at 10pc on shares and other assets and 18pc on property, while for higher-rate taxpayers the rates are 20pc and 28pc.

You only need to worry about this if the profit you have made is greater than the tax-free allowance. The trouble is this was cut from £12,300 to £6,000 last April, and is due to fall again in April 2024 to £3,000.

Mr McCann said: “With the annual exemption having fallen to £6,000 it’s likely many more will be caught in the capital gains tax net.”

WATCH OUT FOR ‘RESERVATION OF BENEFIT’

Capital gains tax is not the only thing you need to look out for when gifting preowned assets.

A gift with “reservation of benefit” is where the donor transfers ownership of an asset but continues to benefit from the item.

Andy Butcher, of wealth manager Raymond James, said: “This is something to be particularly aware of when considering gifting properties.”

Mr McCann said: “To start the seven-year clock ticking, it’s important that you don’t continue to benefit from anything you give away.”

If you keep using the gift, then it will still be considered a part of your estate, and your family could face a tax bill after your death.

This means there are restrictions on regularly visiting family in property you previously owned.

HMRC’s rulebook states that if someone gives away a property, for example, but then visits the new owners almost every weekend and stays overnight, or lives with them for more than one month a year, then it still counts as part of their estate.