How a trick to save in­her­i­tance tax can back­fire spec­tac­u­larly

Gift­ing a prop­erty in the hope of sav­ing tax could ac­tu­ally cost your heirs hun­dreds of thou­sands of pounds.

The Sunday Telegraph - Money & Business - - Front Page - By Harry Bren­nan

We are pay­ing more in in­her­i­tance tax (IHT) than ever be­fore. HMRC raked in £5.2bn from death du­ties this year, a £3.4bn rise com­pared with five years ago, and grow­ing prop­erty wealth means more and more peo­ple will be losing out to the tax­man when they die.

There are a num­ber of ways to pay less, but the com­plex and lit­tle-un­der­stood rules sur­round­ing IHT re­sult in many be­ing caught out.

When you die, £325,000 of your es­tate is safe from tax, plus a fur­ther £125,000 if you are pass­ing your home on to a di­rect de­scen­dant. Any­thing above those thresh­olds will be taxed at 40pc be­fore it can be passed to your fam­ily.

You can re­duce the death du­ties your fam­ily will have to pay by giv­ing them as­sets be­fore­hand, thereby re­duc­ing the value of your es­tate. If the gift, such as a cash lump sum, is made at least seven years be­fore you die, it will be ex­empt from tax.

Tele­graph Money read­ers of­ten ask about the ben­e­fits of giv­ing their prop­er­ties to fam­ily mem­bers be­fore they die to avoid the clutches of the tax­man, but ex­perts have warned that cer­tain pit­falls could re­sult in you pay­ing more than you save.

While it is in­deed pos­si­ble to give away an en­tire prop­erty to sub­stan­tially re­duce the value of your es­tate and there­fore the amount of tax an in­her­i­tor would have to pay, the process is not as tax ef­fi­cient as many would think. One lit­tle-known rule in par­tic­u­lar can throw gift­ing ex­emp­tions out of the win­dow. The rules on a “gift with reser­va­tion of ben­e­fit” (GWROB) are de­signed to stop peo­ple giv­ing away as­sets such as prop­er­ties at the same time as mak­ing use of them.

These rules mean you can­not give your home to your children and con­tinue to live there un­less you are pre­pared to pay the mar­ket rate of rent – a rather tall or­der for most peo­ple in the later stages of life. In or­der for the gift to qual­ify for IHT ex­emp­tion if you con­tinue to live in your prop­erty, you would have to pay rent at the mar­ket rate for at least seven years.

Andy Butcher of Ray­mond James, the wealth man­ager, said the rule also ap­plied to hol­i­day homes. If you wanted to give away your hol­i­day prop­erty but still use it ev­ery now and then, you would have to pay a mar­ket rent for the length of your stay. Oth­er­wise the tax­man could deem the as­set to be part of the over­all es­tate.

Mr Butcher said the tax im­pli­ca­tions of the GWROB rules could be se­vere. For ex­am­ple, a widow who gave away her prop­erty in or­der to re­duce the amount of IHT payable on her es­tate could in­ad­ver­tently leave her son with more tax to pay than if she had done noth­ing at all.

If she con­tin­ued to live in the house af­ter the gift was made with­out pay­ing the mar­ket rate of rent, even if she died more than seven years later, the tax­man could take his 40pc cut un­der the GWROB rules.

More­over, as the widow had made the gift dur­ing her life­time, she would lose her £125,000 fam­ily home al­lowance, as the prop­erty would not have passed di­rectly af­ter death.

Fol­low­ing the widow’s death, the son could also be li­able to pay cap­i­tal gains tax if he de­cided to sell the prop­erty, which could well have risen sig­nif­i­cantly in value over the years since the gift was made. Cap­i­tal gains tax would ap­ply on any money made over the an­nual tax-free al­lowance, cur­rently £11,850, at a rate of 18pc, or 28pc for higher-rate taxpayers.

Mr Butcher said some peo­ple could be leav­ing their fam­i­lies hun­dreds of thou­sands of pounds worse off if they gave away prop­er­ties with­out a thor­ough un­der­stand­ing of IHT rules.

“Many clients ask us about gift­ing prop­erty and ways around this, but un­less they have sig­nif­i­cant in­come and are com­fort­able pay­ing mar­ket rate rental to the ben­e­fi­ciary, it is an area we en­cour­age them to avoid,” he said.

There are other, more ef­fi­cient ways to re­duce your tax bill, such as giv­ing away cash lump sums, mak­ing use of tax-ef­fi­cient in­vest­ing or putting as­sets into trust struc­tures, Mr Butcher added. The fam­ily home al­lowance or “res­i­dence nil-rate band”, which came into ef­fect on April 6 2017, en­ti­tles each in­di­vid­ual to an ad­di­tional amount on top of their ex­ist­ing £325,000 in­her­i­tance tax ex­emp­tion.

The value of the perk, orig­i­nally £100,000, in­creases by £25,000 a year un­til it reaches £175,000 in April 2020; it is cur­rently £125,000. For a cou­ple this means a £1m es­tate will even­tu­ally be able to be left tax free when their al­lowances are com­bined.

How­ever, Chris Ball of Hox­ton, an­other wealth ad­viser, said in­creas­ing prop­erty wealth meant that peo­ple would still be caught out by gift­ing rules, de­spite the new al­lowances.

Prop­erty wealth now ac­counts for 76pc of the av­er­age es­tate, ac­cord­ing to Hox­ton, which says most peo­ple do not un­der­stand the IHT rules. More than three quar­ters of par­ents aged 55 and over find gift­ing rules con­fus­ing and are con­cerned about mak­ing mis­takes, ac­cord­ing to re­search by Key, the es­tate plan­ning ad­viser.

“House prices are go­ing up, so more peo­ple are fall­ing into the IHT net as prop­erty is the bulk of peo­ple’s wealth,” Mr Ball said.

“Peo­ple are pay­ing more tax and look­ing for ways around it. But gift­ing can be a real prob­lem if peo­ple think they can gift a house and still live in it rent-free. These things can be ex­tremely costly fur­ther down the line if you get it wrong and it’s not you who has to pay the tax­man – it’s your children.”

He added that HM Rev­enue & Cus­toms had been step­ping up its ef­forts to raise tax money as the Govern­ment strug­gled to fund pub­lic ser­vices.

“HMRC is al­ways go­ing to tax the low-hang­ing fruit. It is eas­ier for the tax­man to go af­ter the gen­eral pub­lic than com­pa­nies,” he said.

“The Govern­ment needs more money and HMRC is be­com­ing more ag­gres­sive on these things than it used to be, that’s for sure.”

Mr Ball said very few peo­ple would give away their prop­erty if they knew what the im­pli­ca­tions were. He said the idea of pay­ing rent would be a se­ri­ous de­ter­rent for most.

He added that there were al­ways ways for in­di­vid­u­als to re­duce the size of their es­tate by struc­tur­ing their as­sets in a more tax-ef­fi­cient way. For many, IHT should be con­sid­ered a “vol­un­tary tax” as dili­gent fi­nan­cial plan­ning could re­sult in sig­nif­i­cant sav­ings, he said.

Gor­don An­drews, a tax ex­pert at the wealth man­ager Quil­ter, said the rules could be made clearer. “It’s a strug­gle for peo­ple. HMRC does make an ef­fort but the com­plex­ity of these things means they are not al­ways able to make the rules clear to ev­ery­one,” he said.

He added that, de­spite govern­ment ef­forts to make the sys­tem clearer, tax had be­come in­creas­ingly com­plex over the years and peo­ple of­ten strug­gled to keep abreast of changes to the rules and thresh­olds in­volved.

Mr An­drews ad­vised peo­ple to con­sider mov­ing to a smaller, cheaper home and giv­ing away the money left over rather than hand­ing over the prop­er­ties them­selves.

‘Clients ask us about giv­ing prop­erty away but we en­cour­age them to avoid it’

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