Inheritance Tax planning for your home

For many people, their home is their most valuable asset and can give rise to a significant IHT liability on their death (or the death of the surviving spouse). The classic issue for many people is that, on the one hand, they would like to mitigate the IHT liability, but at the same time they would like to remain living in their home.

How can an individual give away their main residence in order to mitigate their future inheritance tax (IHT) liability and continue to occupy, without being caught by the reservation of benefit provisions?

What do the current IHT rules say?

The IHT legislation includes a set of rules known as the “Gifts with Reservation of Benefit Rules”. These complex rules mean that, even though you have given an asset away but you continue to derive a benefit from it, e.g. you give away your home but you continue to live there, you are treated as if you still own it - and it therefore forms part of your taxable estate on death.

Over the years there have been a number of ways of circumventing this problem. The approach that is currently most readily accepted by HMRC is to pay a market rent for your occupation under a secure lease.

Transferring your home to a trust or your children

Typically, this involves two valuers being instructed: one for the homeowner(s) as future tenant(s); and the other for the future owner of the freehold, as landlord(s). Sometimes this will be the owners’ children, but often this is the home owners as trustees of a new family trust, which gives additional security as they retain control of the freehold through this role. The valuers will agree the current market rent between them.

A secure lease is then granted to the homeowner(s), at a market rent and for an appropriate term. The freehold of the property is then transferred to a trust or to their children, subject to the lease.

If the homeowner(s) survive the transfer by seven years and continues to pay the full rent, the value of the freehold (or a share of it) will be entirely outside their estate for IHT purposes.

If the homeowner(s) are not confident they can afford the full rent for the property, they can transfer a percentage interest in the house, rather than the whole.

The advantages to using a trust structure

There are a number of advantages to using the trust structure.

1. The homeowner(s) can be trustees of the trust, which enables them to retain a degree of control and ensures their interests cannot be overridden without their consent. The terms of the lease will also be drafted to help protect their interests. The rental payments also decrease the value in the homeowner’s taxable estate immediately.
2. The rental payments received by the trustees can be used to benefit future generations either immediately or by income being accumulated to capital. It also provides the flexibility to divert income to beneficiaries with lower income tax rates (eg, grandchildren) to ensure maximum income tax efficiency.
3. Using a trust structure ensures both the property and the income arising can be protected from divorce or bankruptcy of beneficiaries.

With proper advice, homeowner(s) can gift all (or a share) of their home to their family to save a significant amount of IHT and retain a secure right of occupation. The caveats to this are that the homeowner(s) need to survive the gift by seven years and can afford to pay the rent.

There are a number of more involved approaches to saving IHT, but the rental approach is the most "tried and tested" and in many ways the simplest.