I want to give my home to my family: Can I rent it back from them to avoid an inheritance tax bill?
My total estate will be worth approximately £700,000 by the time I die.
I would like to transfer ownership of my three-bedroom house, which is currently worth approximately £550,000, to my nephew and nieces (in equal proportions) to benefit from the seven-year rule and avoid inheritance tax.
I would pay market rent to them so the transfer doesn't count as a 'gift with reservation'. I would need, however, to rent out three rooms and live in one room myself to afford the rent.
Would this mean that I am still benefiting from the house in such that it would still be a 'gift with reservation'?
Also, if I sublet the rooms could I still benefit from 'rent-a-room' tax relief on the income, even though I would be a tenant myself? F.A, via email
With reservation: Giving your property away will not be IHT free if you continue to live in it
Harvey Dorset of This is Money, replies: It is good to see that you are planning your inheritance well in advance in order to ensure that you can make the most of the seven-year gifting rule.
If someone gives a financial gift and then dies more than seven years later, there is in many cases no inheritance tax to pay. If they die before that limit is up, however, it is payable on a sliding scale.
The rule is in place to avoid people giving away all their wealth in the last months or years of their life, in a bid to avoid taxes on their estate.
Gifting them your home now could save your nephew and nieces a considerable tax bill down the line.
However, if you still intend to live in the home, that could complicate things.
> How inheritance tax works - and what families MUST know
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HMRC's 'gift with reservation of benefit' rule is in place to prevent individuals from gifting assets during their lifetime that they still benefit from before their death.
For example, gifts where the giver still benefits would not become exempt from inheritance tax after the seven years from when the gift was made, as the individual is still benefitting from the property.
However, with a formal rental agreement and rent paid at the current market rate, it is possible to demonstrate that the giver of the gift is no longer receiving the full benefit - and potentially reduce the tax bill.
This is explained further below by two financial advisers who set out what you need to do to ensure that you can pass on as much of your estate as possible.
Tax burden: Chris Springett says your family will be liable for income tax on your rent payments
Christ Springett, tax partner at Evelyn Partners, replies: The first thing is to estimate how much tax you are looking at saving.
The residence nil rate band, whereby an estate can benefit from a higher inheritance tax allowance if they are passing on their main home, only applies when the property is left to direct descendants. This excludes your nephew and nieces.
Assuming that you have not inherited any nil rate band from a spouse, the tax at stake is therefore £150,000 (40 per cent of £700,000 less the nil rate band of £325,000). As you say, this could be reduced by making lifetime gifts. Reducing your estate at death to the remaining value of £150,000 would mean that no IHT was due. Obviously the size of your estate could change, affecting these calculations.
You are correct that, provided you pay a commercial rent, then the gift with reservation of benefit rules would not apply, and the transfer would, like most other gifts, be a potentially exempt transfer for IHT.
This, however, only applies if you continue to pay the market value rent until you stop using the house - not just for seven years as is sometimes the misapprehension.
To reduce the risk of an HMRC challenge, you would need to take advice on how much the rent should be, and review it regularly to ensure that it keeps pace with the local rental market. This could be challenging, particularly as you will need to keep paying the rent even if you have gaps in rental income from lodgers, or other expenses arise.
There are however several other pitfalls that you should consider carefully, and possibly discuss with your family, before making a final decision. The key ones are:
IHT: If you die within seven years then the property will fall within your estate for IHT purposes. No reduction in the IHT bill will be given if you die within three years of making the gift, but there is a sliding scale of IHT reductions between three and seven years, reaching 100 per cent at seven years.
If you die in this period the nil rate band is also set first against the property, with no sliding scale of reduction in the value deducted from the nil rate band. This means that the remainder of your estate would be subject to IHT (currently at 40 per cent) without any nil rate band left available.
Income tax: Your nephew and nieces will be liable for income tax on the amount of rent received from you. They will probably have to file annual tax returns assuming that they have other income.
CGT: There will be no CGT due on the gift of the property if it has always been your home, as principal residence relief applies. However, this ceases to be the case from the date of gift.
Any increase in the property value between the gift and an eventual sale would be subject to CGT, for which your nephew and nieces would be liable. If it remained in your estate until you died then principal residence relief does not apply but it would benefit from the CGT free uplift on death, if this is not abolished, and so no CGT would be due, just IHT.
This would be particularly galling if you died within seven years of making the gift, as then some IHT would be due, as well as CGT on any increase in property value since the date of gift.
SDLT: If your nephew and nieces want to purchase their own homes while owning a share in yours, then they would be liable to pay the SDLT surcharge for purchasers of additional residential property.
At 5 per cent of the value of a house this could be significant, and also affects anyone with whom they are purchasing a property, as one joint purchaser being liable for the surcharge means that it applies to the whole value of the purchase.
Non-tax issues: In terms of your personal circumstances, thought should be given to if you will have enough assets left to fund the remainder of your retirement comfortably.
This includes funding any care, as making a substantial gift then having to apply for state funding of care leaves you at risk of being accused of deliberate deprivation of assets.
In addition, it would be sensible to discuss what could happen if the arrangement breaks down, for example if a niece or nephew divorces and needs to realise the value of their assets.
An amicable arrangement made relying on current circumstances can face risks if it is potentially decades long, and problems may arise with issues such as your nephew and nieces needing to fund the maintenance of the property like any other landlord.
Other options are to use allowances to make gifts of other assets to your family, though these would have to be less significant given the value of your home compared to your other assets.
Can they sub-let some rooms?
The rent a room scheme is not limited to owner occupiers. As a tenant who sublets rooms you would be able to offset the rent a room relief, currently £7,500, against gross rents assuming that you meet the other conditions such as rooms being furnished.
You would have to choose on a year-by-year basis whether to claim the relief or to set expenses against the rent instead, as it is not possible to do both.
If the rent exceeded this relief, then you would need to pay income tax on this amount, if your total income was in excess of your personal allowance. This is likely to mean you would need to file an annual tax return.
If you had to leave the home for any reason, such as moving into care, then this relief would no longer be available, as it is only for joint occupation. In this scenario however, you might terminate your own rental agreement with your family and cease to be liable for rent.
Paper trail: Andrew Smith says proper documentation is necessary for any rental agreement
Andrew Smith, independent financial adviser at Flying Colours, replies: Inheritance tax is a complex subject and an area of advice that requires careful long-term planning. When thinking of transferring your property to your nieces and nephew to try to reduce any future liability there are a few things to consider.
Firstly, is it necessary? Do you have sufficient allowances to mean that even if you died today, there would be no IHT liability? Most people will not pay IHT on any assets up to £325,000. If you have a spouse, then any assets can pass to them free from IHT on any value. IHT is then calculated upon the second death.
If you are widowed, then you may have inherited your late partners IHT allowances which in this case could total £650,000 (£325,000 x2).
This would greatly reduce the liability to around £20,000 and it could be reduced even further by depleting your assets above this limit, perhaps by using your annual allowance of £3,000 each year to gift to others, plus other small unlimited gifts of £250 and perhaps even spending some on yourself!
I know it is not the case here, but it should be noted that if you were to pass your property directly to children or grandchildren you could also benefit from the residence nil rate band of £175,000 each, potentially taking your total allowance up to £1 million. Therefore, the course of action you have in mind would be unnecessary.
For you to benefit from a reduction of your IHT liability by gifting to your nieces and nephews, you must be very careful that HMRC do not deem your gift as a 'gift with reservation'.
A gift with reservation is where you give something away but continue to benefit from it and it will mean that it is considered part of your estate upon death and taxed as such.
To avoid this, you should take the following steps:
• Your niece and nephew (the landlords) must charge a commercial rent that reflects the market value (as you quite rightly acknowledge).
• Ensure that the arrangement is documented properly with formal rental agreements.
• Consider having the rental payments reflected in your financial records.
You will also have to survive for seven years to be fully free of any IHT liability. The tax liability is reduced on a sliding scale from the third year onwards.
On your point regarding the rent-a-room relief, this scheme allows individuals to earn up to £7,500 per year tax-free from renting out furnished accommodation in their home.
However, in this case you are not the owner any longer and are instead renting a room from your nephew and nieces, so you would not be eligible for this relief. As long as the landlords allow, there are no rules against sub-letting and this shouldn't affect the tax position of the gift.
Finally, you should bear in mind that any rental income would be taxable and dependent on your other income, you may be required to pay tax if you are over your personal allowance.
