How to gift a house

Cut your inheritance tax with property and pension exemptions. By Mike Warburton

All families will be able to pass £1m down the generations without paying a penny in tax – this was the promise of George Osborne in October 2007. The thenshadow chancellor announced to the Tory party conference that he would raise the inheritance tax threshold to £1m and exempt the “family home”.

And while it is true that a couple can in theory pass on £ 1m, in reality Osborne got to this figure in a complex combination of the main allowance and a “family home” add on.

It would have been much more simple, and fairer, to raise the main allowance in line with inflation, which would now make it about £1.75m.

Instead it has been frozen at £325,000 per person for years. Why? The simple answer is that inheritance tax (IHT) is a large and growing money spinner for the Treasury.

The Office for Budget Responsibility expects IHT receipts to bring in about £ 7bn in 2022- 23, rising to £8.4bn by 2027-28.

Telegraph Money recently suggested some ways to limit the damage. This included more use of pension funds, and claiming the residence nil- rate band, introduced incidentally by Osborne in an attempt to honour part of his earlier pledge.

There was understandable excitement in the Budget announcement that the pension lifetime allowance tax charge was being abolished. Because pension funds do not count as part of your estate for IHT purposes this opened up the prospect of making larger pension contributions, subject to the increased £60,000 annual allowance, thereby increasing scope for drawing a larger tax-free lump sum and keeping the balance out of the IHT net.

I fear that it may not be as simple as that. First, of course, if we have a Labour government after the next election they have vowed to bring back the lifetime allowance charge. Second, you cannot be sure that the IHT advantages of pension funds will survive until your demise. Also, the tax free pension lump sum itself could be at risk. It has been locked at 25pc of the current £1.073m lifetime allowance, or £268,275. In my view this could remain frozen so that the dirty work of cutting it is performed stealthily through inflation.

What about the family home? You can leave it to your children or grandchildren in your will and the estate will be taxed less the extra family home allowance. However, what happens if you give the property to your children in your lifetime, hoping to live for a further seven years and thus avoid IHT?

This can create a problem if you continue to occupy the house. As a result of the “reservation of benefit” rules the property will typically continue to be in your estate for IHT purposes. In addition, the property will cease to qualify for the private residence capital gains tax exemption and the “base cost” will not be raised to market value on your death, as would otherwise be the case.

However, there are circumstances where a gift of the home can be effective. The reservation of benefit rules will not apply if you pay your children a full market rent to stay in what is then their property. This rent will potentially be caught for income tax but it may not be a problem if your child has a low income. The seven-year rule counts backwards from death, so rent will need to be paid for as long as you are living there or until your death.

Co- ownership is often overlooked, but in the right circumstances can offer a large IHT saving. For example, suppose your elderly mother is living on her own in the family home. She could gift half her house to you on the understanding that you will live with her part of the time and pay your share of the expenses. There would be no requirement for her to pay you rent and there would be no reservation of benefit.

On her death, assuming seven years had gone by, she would only own half the house and this would be valued at a discount – typically 15pc for IHT purposes. You would need to have real physical occupation of the property, but it would only need to be part-time, such as a night or two a week or perhaps holidays and weekends.

Another consideration is that extra council tax might apply. If your mother subsequently had to move into a care home there is no reservation of benefit and her CGT private residence exemption would continue to apply for three years. You should take appropriate legal advice before proceeding.

‘Shared ownership is often overlooked, but can offer a large IHT saving’

Mike Warburton was previously a tax director with accountants Grant Thornton