Why do people gift property to their children?
Gifting your main residence to children is often seen as a straightforward way to pass on wealth, reduce the size of an Estate, and is a common route for individuals to explore as part of the wider effort to lessen the Inheritance Tax liability on their Estate.
On the surface, this approach appears to be practical and tax-efficient, however, beneath the appeal lies a range of potential pitfalls, from unexpected tax consequences to loss of control and exposure to personal risks affecting the recipient of the gift.
Without careful Estate planning and a clear understanding of the Inheritance Tax rules, what begins as a well-intentional gesture can lead to unintended complications for all parties.
Gift with Reservation of Benefit: Why the seven‑year rule often fails
Many people are familiar with aspects of the gifting rules in England and Wales, particularly that an individual is able to make a gift to another (outside of any annual or small gift allowance), and, provided that they survive 7 years, the gift will be outside of their Estate for Inheritance Tax purposes.
Based on the above, one of the most common misconceptions when gifting property to a family member, particularly when gifting a person’s main residence, is that the original owner can continue to reside in the property, and that merely making the gift of the property to a child or children, will start the 7-year clock for gifting purposes.
However, what many are not aware of is that for the gift to be outside of an Estate for Inheritance Tax purposes after the 7 years is up, is that the individual making the gift cannot retain any benefit in the property. As a result, the individual gifting the property cannot continue to reside in the property, and if they do, the 7-year clock will not start, until the individual has given up all benefits retained in the property.
Should an individual fail to give up their benefits in a property entirely and continue to live there after gifting the property, the value of the property would be seen to still be part of the original owner’s Estate for Inheritance Tax purposes upon death. It is important to note that this is for Inheritance Tax purposes only, and the recipients of the gift will still be the legal owners of the property.
The only way in which an individual could continue to reside in a property after gifting it to another, would be to pay market rent to the new owner(s) of the property. This rent must be assessed and updated regularly in line with genuine commercial rent, as well as other requirements beyond the scope of this Article. Often, this workaround is not a favourable option for many individuals.
Gifting property and deliberate deprivation of assets
A deprivation of assets arises when an asset, property in this case, is gifted to another person, to avoid or reduce the payment of care home fees.
In England, the current threshold for payment of care fees if £23,250- if a person’s capital reduces below this threshold, then they will no longer be responsible for the payment of their care fees, and instead, the Local Authority will step in and make payment of care fees on behalf of the individual, as necessary.
However, that being said, if the Local Authority deem that a property has been gifted with the intention of reducing or avoiding care fees, the Local Authority can deem the value of said Estate to still include the gifted property. Consequently, the individual who has gifted the property, would be personally responsible for funding their care, due to being seen by the Local Authority as having capital above the financial threshold, even though in actual fact, this may not be the case.
It is important to note that unlike the 7-year time limit for Inheritance Tax purposes, there is no time limit on gifts that the Local Authority can look back at in order to assess whether it has been made to deprive their Estate of assets. Factors such as making a gift when an individual is in poor health, or circumstances have arisen which makes it apparent that an individual is likely to need care, are those which are more likely to be particularly scrutinised by the Local Authority.
How divorce, bankruptcy and family disputes can affect gifted property
Whilst the following situations may seem like an unforeseeable extremity for many, you should also be aware of further negative situations and implications of a gift of property to your children.
Firstly, it is important to be aware that, by gifting your property to your children, it becomes part of their Estate. If your child/ children were to end up in financial difficulties, such as bankruptcy proceedings, the property that once belonged to you, would be up for grabs by creditors in order to settle any outstanding debts that your child, as the new owner of the property, may owe. This would be particularly catastrophic if, as above, you had gifted your property to your children whilst continuing to occupy the property, as you would no longer have a legal interest in the property, and if such a situation were to arise, you could find yourself without a place to live.
Similarly, if your child becomes subject to divorce proceedings, the property that you have gifted to them is now part of their Estate for their financial assessment, which may result in a less desirous outcome for them, due to a potential claim by an ex-spouse.
Finally, relationship breakdowns between families can occur even in the most harmonious of family units. In the event that you have gifted your property to a child whilst continuing to reside in the property, and such a breakdown was to occur, your child, as the legal owner, would be able to do as they wish with the property. If such a situation was to arise, you could find yourself not only failing to successfully reduce the Inheritance Tax liability on your Estate, but also without a place to live.
How we can help with Estate planning and Inheritance Tax
If you are considering gifting your property to your children or would like Estate Planning advice in general in relation to managing the Inheritance Tax liability on your Estate, please contact us to arrange a meeting to discuss your specific requirements.
