For most clients, real property (whether the family home or a holiday villa) is one of their main assets. In light of this many people consider making a gift of real property to family members as part of their lifetime tax planning. If there is an outright gift of the property, it will be a potentially exempt transfer. This means that as long as the parent survives for seven years, it will not be included in their estate for inheritance tax purposes on death. This would avoid a potential 40% charge to inheritance tax.
However it is not sufficient to simply transfer the property and continue as normal. Unless there is shared occupation of the property, where different rules apply, the parent must give the property away on a ‘no strings attached’ basis if any lifetime gifting is successfully to avoid inheritance tax. The rules state that the property must be enjoyed to the entire exclusion, or virtually to the entire exclusion of the donor. What this means in practice can be a grey area, with little further guidance on what ‘virtually’ implies and just how much benefit can still be taken.
With HMRC becoming increasingly vigilant of such transfers and asking for more evidence than ever to prove there is no continued benefit, we outline our top tips to ensure a lifetime gift of real property is successful.
1. Document how the ongoing relationship will be governed
In most cases, where the family home is transferred outright to children but the parents continue to live in the property, there could be a lease (on an arm’s length basis) granted to the parents by the children. In cases where the benefit will be on a more ad hoc basis, a licence could record how many nights will be spent at the property and the market rate payable for that. A word of warning. If, in practice the property is available whenever the parents want to use it then an annual rent may still be payable. Income tax will be payable on the rent received by the children but this may be another effective way of getting value out of the estate of the parent.
2. Pay market rent
Even if it is just a week staying in the property or a longer term arrangement, there can be no concessions made. A valuation should be carried out to determine the proper rent payable and this should be documented in the lease or licence. An independent third party valuation should be undertaken and placed on file, so that you can demonstrate to HMRC that the appropriate amount has been paid.
3. Provide for rent reviews
The document should include a rent review clause to ensure that the parent continues to pay a market rent. Without a review clause, there is a risk that in the future the rent will be at a discount when compared to the rest of the market; any saving will result in a reservation of benefit.
4. Obtain a current market valuation
At the time the gift is made, obtain a current market valuation and keep it safe for future reference. This should crystallise the position if there is a death within 7 years so that the gift becomes chargeable. Inheritance tax will only be payable on the value of the property when it was gifted. If property prices go down so that the property is worth less at the date of death, this lower price can be substituted if the property is still owned by the person it was transferred to.
There are other taxes to consider. Stamp duty land tax should not be an issue if there is no consideration received for the gift. In addition, capital gains tax will not be payable if the property being gifted qualifies as a main residence but capital gains tax could be a barrier if the gift is of a second property, rental property or a holiday home. If capital gains tax is payable it makes it particularly important to consider whether life insurance should be taken out to cover the 7 year risk for inheritance tax purposes; an immediate charge to capital gains tax and no inheritance tax saving would not be a good outcome.