May 31, 2017Gifts with reservation of benefit: an overview

Gifts with reservation of benefit

If you’ve ever thought about how you might reduce your inheritance tax bill or avoid losing your assets to care home fees, one option you might have considered is signing your home over to one or more of your children but continuing to live in it. These type of transactions are known as a ‘Gifts with reservation of benefit’. Here we look at:

  • Inheritance tax consequences
  • Income tax consequences (POAT)
  • Capital gains tax consequences
  • Liability for care fees
  • The alternative to making gifts with reservation of benefit

This article is intended as a general overview of the consequences of gifts with reservation of benefit. It is not intended as a substitute for professional advice.

What are gifts with reservation of benefit?

If you make a gift of any property, that gift may be treated as ‘subject to a reservation’ if one of the following applies:

(a) The person you gave the gift to did not take possession of the property or enjoy the use of the property at the beginning of the relevant period, or

(b) At any time in the relevant period, the property was not enjoyed by the person either to the entire exclusion of you or virtually to the entire exclusion of you (see: s.102 Finance Act 1986)

The ‘relevant period’ is the period beginning seven years before your death or, if later, from the date of the gift until the date of death.

These rules apply to all types of gifts, whether it is your family home, a holiday cottage or expensive jewellery.

An example of retaining a benefit would be to give your home to your children ‘on paper’ but actually, continue to live in it.

Another example would be to gift your home to your daughter but put a charge on the property for its value. This would not truly be a gift.

Inheritance tax consequences

Inheritance tax liability

If you give a gift but retain a benefit and the benefit remains there until you die, the value of the gift will form part of your estate for Inheritance Tax purposes on death (assuming it falls outside of your annual gifting allowances).

Alternatively, if you give a gift, retain a benefit but later you give up that benefit, you will be treated as having made a “Potentially Exempt Transfer” (PET) at the point of giving up the benefit, for the purpose of calculating inheritance tax. Potentially Exempt Transfers are gifts that you make during your lifetime that fall outside your gifting allowances. If you survive for seven years after making a Potentially Exempt Transfer, the gift will be free from inheritance tax.

Examples:

  • You put your house into your son and daughter’s names in 2017. You continue to live in it until you die in 2026. This is a gift with retention of benefit and it will form part of your estate for inheritance tax purposes.
  • You put your house into your son and daughter’s names in 2017 but continue to live in it until 2019. You move out in 2019. At this point, the gift becomes a ‘Potentially Exempt Transfer’. You die in 2026. As you survived for 7 years, it will not form part of your estate for Inheritance Tax purposes.

Of note, there are other reasons why putting your house into your son and daughter’s name and continuing to live in it is a risky strategy, which we will cover below.

Exceptions to the ‘gift with retention of benefit’ inheritance tax rules

There are quite a number of exceptions to the above rules and you will need to seek professional legal advice for your individual circumstances. Some exceptions worth mentioning are:

  • If you put the house in your son/daughter’s name but then pay full market rent to them, this would not be a gift with reservation of benefit.
  • If the ‘benefit’ retained is trivial, this will not be classed as a gift with reservation of benefit. For example, you might gift a car but continue to use it a couple of times a month, or gift a holiday home and use it for no more than two weeks in the year.

Note that where you sign over your house but pay full market rent, certain conditions must be met. These include:

  • The rent must be the true market rate
  • A lease or tenancy must be put in place immediately
  • The rent must be reviewed and kept up to date on a regular basis
  • Of course, the rent must also be paid!

Income tax consequences: the Pre-Owned Assets Charge

Where you gift property and manage to circumvent the ‘Gift with retention of benefit’ rules, you may be liable to pay an income tax charge, called the ‘Pre Owned Assets Charge’ (POAT). The POAT  is an inheritance tax (IHT) anti-avoidance measure that was introduced by Schedule 15 of the Finance Act 2004.

The POAT charge is an annual income tax charge where an individual, known as a chargeable person, receives benefits as a former owner of property.

Some examples of where the POAT charge might apply are as follows:

  • George gives ‘The Nook’ to Tim. Tim later sells ‘The Nook’ and buys ‘The Cottage’ with the proceeds. George subsequently occupies ‘The Cottage’.
  • George gives Tim the funds to buy ‘Brownfields’. Tim later sells ‘Brownfields’ and buys ‘The Nook’ with the proceeds. George subsequently occupies ‘The Nook’.
  • George gives a car to Tim. Tim later sells the car and buys a saxophone with the proceeds, which George subsequently plays.
  • George gives Tim the funds to buy a car. Tim later sells the car and buys a saxophone with the sale proceeds which George subsequently plays.

You can elect out of the POAT regime by opting to treat the gift as a ‘Gift with reservation of benefit’. If you do this, you then have the inheritance tax consequences instead. Calculation of the POAT charge is beyond the scope of this article and you should seek professional advice.

Capital gains tax consequences

Tax

Capital gains tax may be payable if you dispose of property, unless relief is available to you. Therefore, if you gift property to your child during your lifetime, the tax may be payable. On a gift between spouses or civil partners who live together, no capital gains tax is payable – but this does not apply to gifts to children.

Capital gains tax is payable on the profit or gain you make when you dispose of a property. If you are gifting the property, the gain is the difference between what you paid for the property and its market value at the time of making the gift.

If you are gifting your home then then Private Residence relief might be available in certain circumstances.

On other types of gift, holdover relief may be available – that is, you and the recipient of the gift can nominate that the recipient pays the Capital Gains liability when they sell the gift. To keep things simple, this is achieved by notionally treating the gift as if it was acquired by the recipient for the price you paid for it. So for example, you buy a holiday home for £10,000. When you give it to your daughter, it is worth £100,000. If you both opt to hold over, it will be treated as if your daughter acquired the house for £10,000. If she sells the property a few years later for £150,000, she will be taxed on the notional gain of £140,000.

Remember that there are possible capital gains and inheritance tax consequences. So, for example, you could give your home to your daughter and thanks to Private Residence Relief, you might not have to pay capital gains – but if you continue to live in it until your death, it will still fall into your estate for Inheritance Tax purposes (unless for example you paid full market rent to your daughter), even if you survive for more than seven years.

Liability for care fees

Gifting a home

Gifting money to help your child purchase their first home is unlikely to be considered ‘deprivation of assets’ if you have no foreseeable need for care.

Gifting a home in an attempt to avoid care fees is an understandable response to the mounting costs of care and lack of protection of family assets afforded by the Government. You work hard for your assets and want to pass them on to your children or grandchildren – but care fees can eat into your savings down to a paltry £14,250. Unfortunately, gifting the home to avoid care fees can have some undesirable consequences.

If you or your partner need care in later life and you are not entitled to NHS Continuing Healthcare funding, the Local Authority will usually conduct a means test to see if you can fund the cost of care yourself. If you have assets above £23,250, you will be expected to pay for the full cost of your care. If your assets are worth between £14,250 and £23,250, you will be expected to make a contribution to your care. Once your assets reach the lower £14,250 limit, the Local Authority will take over funding your care fees.

If you transfer your assets to your children or to a trust during your lifetime and you later need care, your transfer may be regarded as a deliberate deprivation of assets.

The key consideration here is the intention behind making the transfer. The Local Authority must consider:

  • Whether avoiding the care and support charge was a significant motivation;
  • The timing of the disposal of the asset. At the point the capital was disposed of could the person have a reasonable expectation of the need for care and support?; and
  • Did the person have a reasonable expectation of needing to contribute to the cost of their eligible care needs?

If the Local Authority believes the asset was given away to ensure it was not included in a means test, it may decide that you have ‘notional capital’ of equivalent value to that of the asset. In effect, any other assets you have can be used up very quickly. The Care Act 2014 also gives Local Authorities power to recover care fees from whoever you transferred your assets to.

In other words, if you transferred your home to your son, your son is liable to pay the Local Authority the difference between what it would have charged, had the transfer not been made. However, your son would not be liable to pay anything which exceeds the benefit they have received from the transfer. In other words, if your care fees came to £100,000 and your home was only worth £50,000, your son would only be liable for £50,000.  If you transferred your home to three of your children, each would be liable for a third of the difference.

Local Authorities have other powers to recover contributions towards care charges, taking into account any property that has been deliberately given away. They can pursue a claim in the County Court, start insolvency proceedings and more.

Care fees and the myth of the 7 year rule

Many people hold the believe that if you transfer your assets and then survive for 7 years, this is not deliberate deprivation of assets. This so called ‘7 year rule’ is a complete myth. There is a 7 year rule that relates to inheritance tax which we have already explained above but this is something different altogether.

The 7 year inheritance tax rule

If you gift something to another person during your lifetime (outside of your gifting allowances) the gift is known as a Potentially Exempt Transfer. If then you die within 7 years of making the gift, inheritance tax may be payable. This is tapered – so if you survive for less than 3 years the full 40% may be payable; 3-4 years = 32% , 4 to 5 years = 24%, 5 to 6 years = 16% and 6 – 7 years = 8%.

To be clear, the seven year inheritance tax rule is not related to deprivation of assets. As noted by the court in Yule v South Lanarkshire Council, the Local Authority can go back as far as they like when considering whether a gift transferred constitutes deliberate deprivation. Even a gift made 20 or 30 years ago could be considered.

Other risks

If you transfer assets such as your home during your lifetime, other risks include:

  • The person who receives your gift may die or run into financial difficulties. If you are still living in the property, you may find yourself homeless.
  • The person you gift the property to may lose their entitlement to benefits or services based on means testing.

The alternative to gifts with reservation of benefit

Couples who act now can protect their own share of assets from care home fees in a way that is completely legitimate and acceptable to the Local Authority. First, it is important to ascertain if the family home (and any other property) is held as Joint Tenants or Tenants in Common. If the home is held as Joint Tenants, each person owns a 100% indivisible share. When one dies, the other continues to own 100% of the property. If however the property is held as Tenants in Common, each person owns a divisible share of the property (e.g. 50%) which they can leave to whoever they like. If the couple owns the property as Joint Tenants, it is possible to sever the tenancy so that it is instead held as Tenants in Common.

The couple can then revise their Will so that each leaves their share of the property on trust to the other for life. After the first person dies, the surviving spouse or civil partner will have full use of the property for life. They can even move home with the permission of the trustees. Should they need care, the deceased partner’s share will not be taken into account for means testing. This is because they do not own the share outright – they only have a life interest.

A further key point of the above solution is that it is extremely affordable. To find out more, order our free information pack below, without obligation.

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