Can my parents gift their house to me and avoid inheritance tax?
We understand that they have a collective inheritance tax exemption of £1million - two lots of the normal £325,000 allowance, plus an extra £175,000 each because they are passing their home to direct descendants.
The house is freehold, there is no mortgage and neither of our parents have debts. My parents are joint tenants.
They have a small amount of assets, at best worth about £30,000. Their home is worth around £1.07million, so a total estate of £1.1million.
Can our parents transfer their property to my sister and I by a deed of gift, whilst continuing to live there? C.S
Harvey Dorset, of This is Money, replies: Financial adviser tell us they are dealing with a wave of questions like yours, as concerns over inheritance tax intensify.
Unfortunately, it isn't a simple matter of people passing on their property now and then living long enough to avoid inheritance tax thanks to the seven-year rule.
The key issue, as discussed by our experts below, is the taxman won't allow your parents to simply gift their main residence to you while they continue to live in it, unless they agree to pay market rent on the property.
Currently, their estate does not go far beyond the £1million tax-free allowance they will be able to access. As it stands today, you and your sister would need to pay about £40,000.
However, it is worth noting that from 2027, pensions will be brought into the inheritance tax net.
This means that any pots your parents are drawing from will also have to form part of your calculations, and could well mean the IHT liability will be considerably higher.
Despite this, there may be other ways that you parents can reduce the eventual tax bill on their estate that don't involve gifting their property.
This is Money spoke to two financial advisers to find out what you need to know before your parents pass their property to you and your sister.
The inheritance tax gifting rules
Ian Dyall, head of estate planning at Evelyn Partners, replies: Let's start by looking at the key inheritance tax rules regarding gifting, then apply them to your circumstances and finally look at any other relevant considerations.
Outright gifts of money or assets from one person to another are unlimited in size and will not trigger a liability to inheritance tax at the time you make them.
The gift must meet two criteria:
1. It must be an outright gift with no continued use of the asset that has been given away, and no conditions allowing the donor to take the money back if they choose to do so.
2. The donor must live for seven years after making the gift
If the gift is not outright, or can be recalled, there is deemed to be a 'reservation of benefit' and the asset remains in the donor's estate indefinitely for inheritance tax purposes - but not for capital gains tax, which I will cover below.
As you correctly stated, each individual has a nil rate band of £325,000 and a residence nil rate band of £175,000, both frozen until April 2030.
The residence nil rate band can only be used if they leave their home to their children or grandchildren. However, if their estate is worth over £2million on their death, the value of the residence nil rate allowance is reduced by £1 for every £2 that £2million figure is exceeded by.
There are 'downsizing relief' provisions that allow someone to still benefit from the residence nil rate band if they have downsized or sold their home since 8 July 2015.
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Can you parents give you their home?
If your parents gift the legal ownership of the property to you and your sister, but continue to live in it rent free, the gift will be seen as a 'reservation of benefit' and will still form part of your parent's estate on death, irrespective of how long they live, for inheritance tax purposes.
The gift would only be effective in reducing the liability if they move out and live for seven further years, or if they pay a market rent to you and your sister for the use of the property. You and your sister would then be liable for income tax on the rental income.
That may be effective planning if your parents can afford the rent, and your parents live for at least seven years - but the longer they live beyond that, the more income tax you will end up paying. There are also capital gains tax issues to consider (see below).
Whether there is a reservation of benefit or not, your parents would be able to benefit from both their nil rate bands and residence nil rate bands.
However, there would be no inheritance tax liability if the gift was seen as effective, due to the payment of a market rent, whereas there would still be a liability if the property remained part of their estate due to a reservation of benefit.
That liability may only be £40,000 today (based on your estimated figures) but that is likely to increase over time due to the frozen nil rate bands.
Capital gains tax
Whilst the gift will be ineffective for reducing inheritance tax if your parents continue to live there rent free, the gift will be effective for capital gains tax (CGT) purposes.
At the time the gift is made there will be no CGT payable as the property is your parents' main home.
But when you and your sister eventually sell the property, any gain in value from the date it was given to you will be liable for capital gains tax, as it is not your main residence.
In contrast, if your parents continue to own the property any gains on the property up to their death will be exempt from inheritance tax.
There are other factors to consider. What would happen if either you or your sister get divorced or become bankrupt? The property your parents have gifted to you may need to be sold, leaving them homeless.
Finally, if your parents ever need long term care, the gift could potentially be seen as 'deprivation of assets'. This is when older people deliberately get rid of money, property or other assets to reduce their liability to pay their own care home fees.
If that is the case, then the value of the home may still be included in any care fees assessment.
Whilst there are some inheritance tax benefits from gifting a property and paying a market rent to continue living there, the potential risks posed by divorce or bankruptcy of the beneficiary, and the additional income tax and CGT that will be incurred, also need to be considered.
Gifting a property and continuing to live there rent-free is generally best avoided as there are very limited benefits, and they are generally outweighed by the risks.
Beware the strain gifting could make on relationships
Rob Bell, chartered financial planner and founder of Finova Money, replies: From what you've described, your parents' estate is only just over the joint inheritance tax exemption of £1million.
Assuming both the standard nil-rate bands (£325,000 each) and the residence nil-rate bands (£175,000 each) are available, there could be a potential tax charge of around £40,000 on the balance above that threshold.
It may be sensible to assume the property could increase in value over time, so this could rise further.
When it comes to gifting the family home while continuing to live in it, this isn't a straightforward way to reduce inheritance tax. The key issue here is who benefits.
If your parents remain in the property without paying full market rent to you and your sister after the transfer, His Majesty's Revenue and Customs would likely view it as a gift with reservation of benefit.
That means, in effect, the property would still be treated as part of their estate for inheritance tax purposes, even if the legal title has been changed. So, the hoped-for tax saving may not happen.
If they did pay you full market rent, this might be avoided. However, surplus income would be needed to pay the rent in addition to ensuring they could maintain their desired lifestyle.
There would also be additional considerations for you and your sister: rent subject to income tax, potential rent reviews, the responsibility for maintaining the property, and the practical reality of charging your own parents rent for their home. This can add strain to your relationship.
On top of this, giving away the property removes your parents' financial safety net. It leaves them without control of their main asset, which could impact their ability to respond to changes in their circumstances, particularly if care is ever needed or if further financial support is required later in life.
These things can be hard to think about now, but flexibility often becomes more important with age, and what may not seem important to them now may become more important later.
How else could they reduce inheritance tax?
There are other ways to reduce the potential inheritance tax bill that don't involve giving away the home. These could include:
Moving house to release capital, which could then be gifted (subject to the seven-year rule), while bringing the value of the estate below the £1million allowance. This may also be a benefit if the house becomes too much to maintain.
Regular gifts from income, which can be immediately exempt if they meet the right criteria.
Updating wills and making full use of both sets of allowances, including the residence nil-rate band, which has its own conditions.
Life insurance written in trust, to cover any future tax liability.
Equity release or a loan secured against the property to release funds that could be gifted gradually, ideally from surplus income.
It's worth exploring these alternatives to understand the wider picture, not just the tax impact.
Often, a more measured plan provides both peace of mind and more flexibility for everyone involved.
Before entering a new arrangement, I recommend seeking professional financial and legal advice.
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Financial planning can help you grow your wealth and ensure your finances are as tax efficient as possible.
A key driver for many people is investing for or in retirement, tax planning and inheritance.
If you have a financial planning or advice question, our experts can help answer it. Email: financialplanning@thisismoney.co.uk.
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We will do our best to reply to your message in a forthcoming column, but we won't be able to answer everyone or correspond privately with readers. Nothing in the replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
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