Why Transferring Your Home to Your Children Doesn’t Avoid Inheritance Tax
Many homeowners consider transferring the title of their primary residence to their children in an attempt to reduce or eliminate inheritance tax (IHT) liabilities. However, under UK tax law, specifically HMRC’s Gifting with Reservation of Benefit (GROB) rule, such a transfer generally does not provide any inheritance tax benefits. Here’s why:
Understanding the Gifting with Reservation of Benefit Rule
The Gifting with Reservation of Benefit (GROB) rule prevents individuals from avoiding inheritance tax by gifting assets while continuing to enjoy the benefits of those assets. If a person gifts their home to their children but continues to live in it, HMRC will still consider the property part of their estate for inheritance tax purposes. This means that when the original homeowner passes away, the property remains subject to IHT.
Conditions That Trigger the GROB Rule
For a gift of a property to be effective for inheritance tax purposes, the original owner must:
- Completely relinquish benefit and control: The former owner must move out or pay a full market rent to continue living in the property.
- Ensure independence from the property: Paying below-market rent or maintaining significant control over the property’s use will cause HMRC to classify the gift as having a reservation of benefit.
- Consider the tax implications of paying rent: Even if full market rent is paid, this may not be a good solution as the rental income will accrue to the children’s overall income and be taxed at their respective income tax band rates, potentially increasing their tax liabilities.
If these conditions are not met, the property remains within the original owner’s estate, and the anticipated IHT benefits are not realized.
Case Study: Mr Patel’s Attempt to Avoid Inheritance Tax
Mr Patel, aged 75, owns a house worth £600,000 and wants to reduce his inheritance tax liability by transferring the property to his two children. He continues living in the house without paying rent, assuming the transfer will remove it from his estate for tax purposes.
Outcome:
- Under the GROB rule, since Mr Patel still benefits from the property, HMRC treats the gifted amount as part of his estate when he passes away.
- Upon his death, assuming no other exemptions apply, the estate is liable for IHT at 40% on the amount above the nil-rate band (£325,000) and the residence nil-rate band (£175,000).
- This results in an IHT charge on £100,000 (£600,000 – £325,000 – £175,000) = £40,000 in tax liability.
Alternative: Paying Market Rent
To comply with tax rules, Mr Patel considers paying market rent of £1,500 per month (£18,000 per year) to his children.
- Over 10 years, this amounts to £180,000 in rent paid.
- However, his children must declare this as rental income, and if they are higher-rate taxpayers (40%), they will owe £72,000 in income tax over that period.
Thus, even paying rent does not necessarily make this a tax-efficient strategy.
Other Pitfalls of Transferring a Property
In addition to the GROB rule, homeowners should consider other risks and drawbacks of transferring their home to their children:
- Capital Gains Tax (CGT) – If the children later sell the property, they may face CGT on the increase in value from the date of transfer.
- Loss of Control – Once transferred, the parents lose legal ownership, meaning children could make decisions about the property without the parents’ consent.
- Financial Risks – If a child faces financial difficulties, divorce, or bankruptcy, the property could be at risk of legal claims.
- Potential Care Home Fees – Some individuals believe gifting their home can help them avoid means-testing for care home fees, but deliberate deprivation of assets rules can override this strategy.
Conclusion
Transferring the title of a primary residence to children while continuing to live in it does not provide any inheritance tax advantages due to the Gifting with Reservation of Benefit rule. Additionally, paying market rent to comply with the rule may introduce further tax liabilities for the children. If estate planning and inheritance tax mitigation are concerns, seeking professional financial advice is essential to explore legitimate and tax-efficient strategies.
There are several other solutions to solving your inheritance tax problem.
