In an earlier article, Dhruva Patel, wills and probate specialist, with Berry & Lamberts Solicitors, explained how making gifts of money or property during your lifetime could help reduce the inheritance tax payable on your estate when you die. In this article she looks at how making potentially exempt lifetime transfers, under what is known as the ‘seven-year rule’, could further assist in reducing your inheritance tax liability.
The potentially exempt transfer rule allows you to make gifts during your lifetime of unlimited value and, provided the gifts in question were made seven or more years before you die, they will be exempt from inheritance tax. If you do not survive for the full seven years, but do survive for at least three years after the gifts were made, any inheritance tax due on the gifts may be reduced on a sliding scale, depending on the total value gifted.
To be effective for inheritance tax planning purposes, you must not benefit from anything that you gift under the potentially exempt transfer rule. So, for example, you cannot give away a rental property and then carry on receiving the rent from it. You also cannot give away your main residence and continue living in it, unless you pay a market rent to the person you have given it to and pay all bills related to the property.
You should be aware that anything you give away may be subject to capital gains tax, if you have made money on it during your period of ownership. Say, for instance, if you bought a rental property for £150,000 several years ago and it is now worth £250,000, if you choose to give the property away you will have to pay capital gains tax on the gain of £100,000. However, you will be able to deduct an annual capital gains tax exemption, together with any allowable expenses incurred during your period of ownership.
There is a potential issue where both capital gains tax and inheritance tax may become payable. For example, if you give away your home (on which you have made a gain), you would be liable for capital gains tax; if you then die within the next seven years, inheritance tax may be payable.
Who pays the tax if I die within seven years of a potentially exempt transfer being made?
If the value of the gifts you have made is less than your nil rate band when you die, there will be no tax to pay on the gifts; however, the tax-free amount available to anyone else who stands to benefit from your estate once you die will be reduced accordingly.
If the value of the gifts you have made is over the nil rate band allowance then inheritance tax on the gifts will become payable. The persons primarily responsible for this tax are the recipients of the gifts. Because of this, you might consider taking out insurance for a seven-year term to cover the tax liability that may arise if you die within this period.
Do I need to change my Will?
When making lifetime gifts you should review your Will. You can, for example, change your Will to stipulate how any tax arising on the gifts after your death should be dealt with. You can also include a provision that takes into account any gifts you have made during your lifetime, so that an individual’s share of your estate is effectively reduced by the value they have already received.
Can I give away assets so that I do not have to pay care home fees?
Giving away assets, by whatever means, as an attempt to avoid paying care home fees is not advisable. Where there has been a deliberate attempt to reduce the value of your assets to avoid paying care home fees, your local authority has the power to effectively ignore the gifts you have made and require care home fees to be paid by the recipients of the gifts.
If you own your house jointly with someone else, you might consider giving away your respective shares in the property by putting them into a trust on the death of the first of you, this would be to protect the share which is in trust from being used towards the care fees in the event the survivor needs to go into a care home at some point. Putting such an arrangement in place will, however, attract potential tax consequences and therefore, requires specialist advice.
What else do I need to consider?
I always advise my clients to err on the side of caution when considering lifetime gifting. It is never a good idea to give away your main asset or leave yourself without sufficient assets to provide a good standard of life for you in your later years or in the event of unforeseen circumstances. Any gifts should be considered carefully and should only be made if your standard of living will not be adversely affected and your remaining assets will be sufficient for you to live comfortably, even if your circumstances change.
The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.