Gift and leaseback of property: Inheritance Tax planning

Property owners looking to mitigate Inheritance Tax liabilities, may consider the gift and leaseback of property as an option. However, it is vital that this is done carefully, to ensure the value of the property is not included in the estate valuation when the time comes. Before deciding on the gift and leaseback of property, you should take legal advice.  It is not the right option for everyone and can have serious implications.
Inheritance Tax
If the value of an estate is more than £325,000 after death, then Inheritance Tax is payable.  Apart from when everything above the threshold is being left wholly to a persons spouse, civil partner or charity. Leaving property as a gift to children or grandchildren, allows for an additional allowance of £175,000, increasing the threshold to £500,000. If a spouse or civil partner has predeceased you and did not use their Inheritance Tax allowance, this can be transferred to your estate.  Thus 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, property values will take estates above the allowance.
Gift and leaseback of your home
To potentially reduce your Inheritance Tax burden, consider gifting your home while you’re alive and leasing it back at full market rent. If you survive for seven years after the gift, the property typically won’t be included in your estate’s value for Inheritance Tax purposes. However, be warned: you cannot retain any benefit from the property. A gift and leaseback arrangement occurs where a property is given as a gift to someone, usually a child or a trust set up for the purpose.  The person making the gift leases the property back. It is vital that the rent paid is the full market value. If not, HM Revenue & Customs will consider that you have only made a ‘gift with reservation of benefit’, ie. not a full gift of your property.  Subsequently, 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 are not classed as a gift, so Inheritance Tax is not payable on the amounts paid.  This also applys to amounts paid during the last seven years before death.
General implications of giving away property
  • Market rent: The authorities might suspect you’re keeping a benefit if the rent isn’t at market value. Make sure the rental agreement is formal and documented. Get valuations to back up the agreed rent in case of investigation.

  • Long-term Affordability: Can the person you’re gifting to afford market rent for the rest of their life, including potential care home fees? If the local authority finds they can’t afford care after giving away the property, they might consider it a deliberate deprivation of assets. Causing them to refuse funding, requiring the transfer to be undone, or even looking back at your finances further.

  • Protecting the Gift: Consider how the gift might be affected in the future. If you gift the property to your child and they get divorced, their spouse could have a claim on it. Similarly, if they go bankrupt, the property could be used to pay off debts. Setting up a trust might be a good way to protect the property.

  • Staying in the Property: If you want to stay in the property indefinitely, make sure you have a solid relationship with the new owner. If you fall out and they want to sell, you might be forced to leave.

Tax implications of giving away property
Also the tax position needs 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. Passing away within seven years of making the gift, means Inheritance Tax is payable on the gift value on a sliding scale. A recent gift would attract higher tax, while a gift made longer ago would be a lower sum. While gifting and leasing back a property can be advantageous, it is important to take legal advice from an expert.  There are many implications to be aware of and these should be discussed before any decisions are made.
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