This is a common misconception that we come across regularly; people hear from friends that they can give away assets without incurring inheritance tax if they survive for more than 7 years.
The Finance Act Rules
Unfortunately this is not strictly true. If you gift an item to someone and then continue to receive a benefit from it once you have given it away, the value of the asset is included in your estate when inheritance tax is calculated to following your death.
These are called gifts with a reservation of benefit and the Finance Act 1986 introduced the rules which deal with such gifts. The rules apply if:
- An individual disposes of property
- By way of a gift (i.e. a sale for full market value will not fall under these rules)
- After 17 March 1986 (when the rules came into force)
- And either:
- (a) The recipient of the gift (the donee) does not assume actual possession (i.e. by occupying or
- receiving income) and enjoyment of the property; or
- (b) At any time the gift is not enjoyed to the entire exclusion of the donor and of any benefit to them
What is reservation of benefit?
The common examples of a gift with a reservation of benefit are parents gifting the family home to their children whilst still residing in it free of rent, or parents gifting a holiday home to their children and then continuing to use it rent free. In both circumstances, the reservation of benefit rules may be avoided by the payment of full market rent by the donors to the donees.
If the donor later dies and a gift is deemed to be a gift with reservation of benefit, it is assumed that the donor had a beneficial interest in the asset and it is as such treated as being part of their estate for inheritance tax purposes.
Further, the free uplift in relation to Capital Gains Tax is not available. Usually, a gift received under a will be deemed to have been acquired by the beneficiary at the value of the gift of the date of death of the deceased. However, if it is deemed that it is a gift with the reservation of benefit, the donee will be deemed to have acquired the asset at the same value as when the deceased purchased the asset, depending on the nature of the asset, this can be an expensive problem.
Change of circumstances for the donor
One of the exceptions for the rules is where there has been a change of circumstances for the donor.
For example – John Smith falls ill 5 years after gifting a property to his son, due to his illness he is forced to move in with his son who can care for him. In such circumstances, the change of circumstances must have been unforeseen at the time of making the gift, it must not have been brought about by the donor to enable him to benefit and the donee must be a relative.
If you want to discuss gifts, the reservation of benefit rules and how these may affect you, please give our specialist Wills, Trusts and Probate solicitors a call on 0800 988 7756 or get in touch online by clicking here.