Having your cake and eating it? Gifts reserving a benefit

The well-known idiom and proverb “to have your cake and eat it too” expresses that a person can’t have two desirable, but incompatible things at the same time. As much as anyone may want both good outcomes, if they’re conflicting and mutually exclusive, they simply must make a choice between them. While we may not naturally associate this proverb with gifting your property to your children, it is surprisingly applicable.

Reserving benefit – what does this mean?

There may come a time when you decide to gift your property to your children (lucky them!) with a view to reducing the inheritance tax on your estate. While many people are aware that if they survive a gift by seven years, then that gift will no longer be considered to form part of their estate for inheritance tax purposes, it is important that it is a complete and perfect gift, to prevent HMRC considering this as a “gift with reservation of benefit “(aka having your cake and eating it).

Case example

It is not sufficient to simply transfer legal ownership to your children. They must also have exclusive use of the property. One, perhaps not so common example to illustrate this, would be if Suzanne owned a 40-foot cruising yacht worth £60,000 which she gives to her daughter Mary in September 2015. From this point on Mary is responsible for the general maintenance, but Suzanne borrows the yacht a couple of times a year with friends.

In August 2018, a guest on the cruise, who is a private client solicitor, points out that the use of the yacht means that Suzanne has all the advantages of ownership, without any of the burden of upkeep or the expense. Therefore HMRC would consider it to still be part of Suzanne’s estate for inheritance tax purposes. In order to prevent this, Suzanne starts to pay Mary an appropriate charter fee whenever she uses the yacht. The payment is supported by a memorandum of understanding. At this point the gift becomes a potentially exempt transfer (PET) and will not form part of Suzanne’s estate, if she survives it by seven years.

Can you give your home to your children and still live there?

It is important to note that if you remain living in the property after you have given it to your children, then this will be deemed a gift with reservation of benefit. In essence you have gifted the property in title only, as you are still treating the property as your own. If you want to continue living in the property and for this gift to be effective for inheritance tax, you will need to pay market rent to your children, which should be formally reviewed on an annual basis. Your children may have to pay income tax on the rental income they receive from you. This is possible if you have surplus income or capital cash reserves, but careful records must be kept, as HMRC are very likely to scrutinise such an arrangement.

What about Capital Gains Tax (CGT)?

Additionally, you should take advice on whether there is any CGT liability, as a gift is a chargeable disposal for CGT purposes.  If you live in the property you give away, the Principal Private Residence relief will apply.  However, tax is swings and roundabouts, as if you give away a property you do not live in, then you may have a CGT charge to pay, even if the gift is effective for inheritance tax, if you survive for seven years.  If you die within the seven years, you could end up paying CGT and inheritance tax! Some careful calculations must be considered before proceeding with such a gift.

It is also worth bearing in mind that if you give your home to your children and pay them a market rent, you will be living in a property you no longer own, or only partly own. If any of your children die, divorce or are made bankrupt, their value in your home will be taken into account by HMRC for inheritance tax, in any divorce financial settlement and by the trustee in bankruptcy, putting your home at risk. 

Additionally, when your children come to sell the property, if they own another property which is their main residence, they will have to pay CGT on any gain in value between the date you gave the property to them and the date of sale. If it is not their main residence, the Principal Private Residence relief will not apply. Accordingly, a robust valuation of the property will be needed as at the date of the gift.

An exception to the rule

There is one tiny exception to this rule. If an adult child lives with a parent and always has done, and intends to do so until the parent dies, then a gift of part of the value in the property can be made to that resident child and the gift does not fail for inheritance tax purposes due to the gift reserving a benefit rules. It is vital that the child does not pay the parent anything in consideration of the gift and so all property expenses must either be paid by the parent or proportionally by the parent and child, according to their percentage shares in the property. Careful attention must be paid if there are other children who do not reside in the property and a review of the parent’s will recommended to ensure the gift to the resident child is taken into account, usually by including a discretionary trust in the will. The same risks of death, divorce or bankruptcy apply as always with any form of joint ownership of property.

If you are thinking of giving away value in an asset you want to continue to enjoy, whether a boat, property, car or picture, please take legal advice to ensure that you do so in a tax effective way.