This will not affect everyone one but if you inherited a property several years ago which you keep as a weekender. You want to retain the property but reduce its value in your estate for inheritance tax purposes. Is it possible to achieve both of these goals?
It’s no give-away
As you probably know, where you make a gift to another individual there’s no inheritance tax (IHT) as long as you survive at least seven years. However, if you give away an asset, such as a holiday home, say, to your adult children, but continue to use it (this is known as reserving a benefit), anti-avoidance rules mean it remains part of your estate for IHT purposes. The seven-year clock only starts ticking when you stop using the asset.
Tip. If you gave away your second home to your children the anti-avoidance rules don’t apply if you only pay them a brief visit, or maybe even stay the occasional night. The law says that as long as you’re “virtually entirely” excluded from using the property, you’re OK. Of course, your idea of virtual exclusion might differ from HMRC’s.
You can’t rely on the “virtually entirely” get-out clause to achieve what you want, i.e. to get the property out of your estate, so you need a more robust strategy, especially if you want to be able to continue to use the property for your holidays.
Tip. If you pay rent to your children at a commercial rate when you stay (other than for brief visits when your children are using it), HMRC accepts there’s no reservation of benefit.
Pros and cons of rent
If you’re trying to reduce your estate then paying rent to your children for use of the property of, say, £2,000 a year, isn’t a bad idea. This means your estate is reduced further, but the downside is that the rent is income for your children on which they must pay income tax.
In April 2017 a new tax exemption was introduces which allows individuals to receive up to £1,000 per year in rental income tax free. Your children can use the exemption to avoid or significantly reduce their tax liability on the rent you pay them. However, there might be an even better option.
Tip. By only giving your children a joint share of the property and keeping a share for yourself, you won’t have to rely on the “virtually entirely” exclusion rule or pay rent. Subject to just two simple conditions, you can continue to use the property when you like and the value of the share you give away will cease to be part of your estate for IHT purposes after seven years.
As long as you and your children can use the property and you all share the running costs, there will be no reservation of benefit for you. The simplest way to prove to HMRC that expenses are being shared is for you and your children to contribute equally to a joint bank account set up to meet property running costs. Note. There could be capital gains tax payable when you give away assets, such as a second home, so check this before you go ahead.
What to do next
This post is our attempt to make an article recently released in Tax Essentials for Advisors accessible to all. Why not leave a comment and let us know how we did? For further information on this and other topics then request more information or contact us at 01332-369999 or through the contact page of our website www.milestone-solutions.co.uk