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Minimising IHT – by gifting the house

What is Inheritance Tax (IHT)?

Inheritance Tax (IHT) allowances have failed to keep pace with soaring house prices and many more people now have to consider the IHT legacy they are leaving to their beneficiaries. What options do you have to avoid IHT if your home takes you close to or over the current £325,000 individual IHT limit (or £650,000 for married couples and civil partners, tax year 2010/11) without allowing unscrupulous or disorganised relatives to leave you without a roof over your head?

Just signing the property over is not really an option

Despite all the urban myths, the one thing you definitely cannot do is simply sign your house over to your descendants and continue to live in it. This is called a 'gift with reservation' and is ultimately inefficient for tax planning purposes as the house will continue to form part of your estate. The only way to get round this is to pay the beneficiaries a market rent, but this is unlikely to be a popular option for those who have scrupulously paid off their mortgage in order to enjoy a comfortable retirement. It also opens the door to your house being sold from under you if your beneficiaries get into financial trouble.

So what options do you have? 

You could sell, move out and rent, or buy somewhere smaller, gifting the balance of your gain to your beneficiaries. This is called a potentially-exempt transfer (PET) and becomes IHT-free as long as you survive 7 years. If you have a big enough house, you could arrange joint ownership and live together in the house. That proportion of the house then is then a PET and again, is IHT free as long as you survive 7 years.

What about larger estates?

For larger estates, there are some more complex schemes. ‘Shearing’ involves selling the freehold and obtaining a short-term lease. Another arrangement involves selling the freehold in return for a lease for life and cash. This cash goes into a trust and the freehold becomes a PET. However, such schemes need to be constructed with the help of a financial adviser to make sure they meet the regulations - and also to ensure that an equitable deal is done.

There are no easy ways to avoid IHT if a lot of your equity is tied up in your main house. However, you can at least maximise use of all the other allowances available to ensure you at least way lay the tax man and in the meantime, still keep a roof over your head.

Giving the house to the children has implications

If your estate is above the inheritance tax threshold, it can sometimes seem a good idea to try giving away your house to your children while you are still alive. As long as you survive seven years from the date you give it, it’s theirs, right? Well no, not exactly. There are a few things you need to bear in mind. First, you will have to pay them a full market rent to live there or it stays in your estate as a gift with reservation - and your children will pay tax on that rent. As it becomes their property, if they become bankrupt, or divorce, it may be sold from under you. And, as a second home, they will be subject to capital gains tax on the price rise when they do finally sell anyway. Take advice to find a better way.

To contact John Pearson, who is a specialist taxation solicitor, please use the details provided below.