Does gifting your home to your children really avoid inheritance tax?

 A commonly recommended way to reduce inheritance tax (IHT) is to make lifetime gifts.

In simple terms, if you survive for seven years after the gift is given, it’s usually excluded from your estate and not counted in the inheritance tax calculation.

For most people, their home is by far the largest asset they’ll be passing on.

So, it’s logical to consider giving it to your children while you’re alive, hoping to avoid the tax.

Unfortunately, it’s not quite that simple. Here’s why.

You can gift your home to your children

Through a deed of gift, you can transfer ownership of the property to your child or children without them needing to pay anything for it.

They simply need to be over 18.

If it’s your only property, there won’t be a tax bill to pay at this point – although it’s a little more complicated if you’ve ever let it out or owned another property at the same time.

HMRC rules for “gifts with reservation”

A gift with reservation is where you’ve transferred legal ownership of an asset to someone else but retained the right to use it.

For example, you’ve put your home in your children’s name, but you’re still living there.

In these cases, the gift is not excluded from your estate when you die, as it was never fully given away.

The change in ownership would have no impact on your inheritance tax position.

It’s only a gift if you move out - or pay rent

To avoid being seen to benefit from the property, you’d have to either leave it or live in it under the same terms as any other private tenant.

You’d need to document the current market rate for the rent and review it annually. You’d be required to make payments at that level to the new owner (your child or children), which they could not return to you.

And like any landlord, they would need to declare this rental income and pay tax on it. Since they’d acquired the home at no cost, the income tax over many years could be significant.

When they eventually sell the property, they will likely need to pay capital gains tax on the proceeds.

This will be calculated based on the increase in value from the time of the gift to the time of the sale.

Gifts with reservation may be taxed twice

Unless you’ve precisely followed these rules, the gift will have “failed” for inheritance tax purposes.

However, the legal transfer of ownership will have succeeded, meaning the capital gains tax consequences will still apply.

In the worst-case scenario, you may have created a capital gains tax bill when your children come to sell the property, without having reduced the IHT bill on your estate.

IHT reduction isn’t always necessary

While it’s sensible to consider ways to manage inheritance tax, remember that only around 5 per cent of estates currently pay inheritance tax – in the other 95 per cent of cases, the entire estate is passed on tax-free.

You might find that the inheritance tax threshold is more generous than you thought. A married couple can often pass on up to £1 million before reaching it, because:

Assets passed from one married partner to the other are always tax-free

Each partner has a ‘nil-rate band’ of £325,000, which can be passed to anyone tax-free

Each partner also has a ‘residence nil-rate band’ of £175,000, which applies if they are passing on their home (their main residence) to a direct descendant (though it’s tapered if the total estate exceeds £2m)

If the first partner doesn’t use their allowances when they die, they can be transferred to the surviving partner

Other ways to reduce your bill

If you’re unmarried, you live in a £1m property, or have other assets that will exceed your nil-rate bands, there are two main options to consider.

Firstly, you could give away assets other than your home to reduce the size of your estate. These gifts would need to fall within your gifting allowances, or they’d be subject to the seven-year rule.

Secondly, you could take out a life insurance policy, written into trust for your beneficiaries, to pay a sum equal to your expected inheritance tax bill. Instead of reducing the bill, this covers it, so that your child or children will inherit the full amount you intended.

There are also various, more complicated planning opportunities. Given the value of the assets involved, it could be well worth paying for professional advice to explore these.