For property owners looking to mitigate Inheritance Tax liabilities, gifting property and leasing it back may be an option. It is vital that this is done carefully however, to ensure that the value of the property is not included in the estate valuation when the time comes.
Before deciding to gift and leaseback your property, you should take legal advice as it is not the right option for everyone and can have serious implications.
After someone’s death, if the value of their estate is more than £325,000, then Inheritance Tax will be payable, unless they leave everything above this threshold to their spouse, civil partner or charity.
If you leave your home to your children or grandchildren, then there is an additional allowance of £175,000, which increases the threshold to £500,000. Where your spouse or civil partner has predeceased you and did not use their Inheritance Tax allowance, this can be transferred to your estate, giving a potential total allowance of £1 million.
The standard rate of Inheritance Tax is 40% of the portion of the estate above the threshold.
For many people, the value of their property will take their estate above the allowance.
Gift and leaseback of your home
A potential solution to this is to give your home away during your lifetime and lease it back at a full rent. Provided you live for a further seven years after making a gift, whatever you have given will not generally be included in the valuation of your estate for Inheritance Tax purposes, provided you have not retained any benefit in it.
A gift and leaseback arrangement occurs where a property is gifted to someone, usually a child or a trust set up for the purpose, and then the person making the gift leases the property back. It is vital that the rent paid is the full market value. If it is not, then HM Revenue & Customs will consider that you have only made a ‘gift with reservation of benefit’, ie. not a full gift of your property, and Inheritance Tax would still be payable on its value.
A further benefit is that rent payments have the potential to reduce the amount held in an estate. Rent payments will not be classed as a gift, so Inheritance Tax will not be payable on the amounts paid, even the amounts paid during the last seven years before death.
The implications of giving away property
The main point to be wary of is that you may be considered to have retained a benefit in the gift if the authorities do not believe that you are paying a full market rent. The rental agreement should be formal and properly documented. Valuations should be sought so that they can be used to back up the agreed rent payments in case of investigation.
It is also important to ensure that the person making the gift is financially able to pay a full market rent for the rest of their life and that they will have enough money to cover other expenses, for example, care home fees. If property is given away and they are not able to finance care, the local authority may find that there has been a deliberate deprivation of assets to avoid paying for care. In this case, they can refuse funding and may require the transfer to be voided. There is no time limit to how far back the local authority can look in considering a transaction.
You will also need to consider how safe the gift will be. For example, if you give your property to your child and they subsequently divorce, their spouse could be entitled to half. Similarly, if they become bankrupt, their trustee in bankruptcy would be able to use the home towards clearing the debt owed. You may be advised to put property into a trust to safeguard against it being lost in this way.
The tax position will also need to be considered. If it is your second home, you will be liable for Capital Gains Tax. Your child is likely to have to pay income tax on the rental income they receive from you.
If you were to die within seven years of making the gift, Inheritance Tax would be payable on its value on a sliding scale. A recent gift would attract higher tax, while a gift made longer ago would be a lower sum.
Finally, if you wish to stay in the property indefinitely, you need to be sure of your relationship with its new owner. If you were to fall out and they wished to sell, you may find you have to leave.
While gifting and leasing back a property can be advantageous, it is important to take legal advice from an expert before going ahead as there are many implications to be aware of.
If you would like to speak to one of our expert estate planners, ring us on 01634 353 658 or email us at [email protected]