My widowed father, aged 86, has around £500,000 in savings and cash. My mother died more than 20 years ago, leaving her money and remaining work pension to my father. About that time, my father transferred the title of his three-bedroom house to myself and my two brothers in equal proportions, while he lives in the house rent free. The house is now worth around £250,000. My father gifts around £3,000 a year each to my brothers and me, and around £300 a year to each of his five grandchildren. He is concerned over how much inheritance tax we will need to pay after his death. What can he do to ensure that his estate passes to his family without the need for inheritance tax (IHT)?
Since October 2007, it has been possible for spouses to pass their nil-rate band to each other for inheritance tax purposes.
Each individual currently gets a nil-rate band of £325,000 before they have to pay inheritance tax (IHT) of 40% on their estate.
The surviving spouse can therefore potentially double their existing nil-rate band. This would mean they could leave £650,000 to their beneficiaries without having to pay a penny in IHT. As a result, your father’s nil-rate band would be £650,000, which would not be subject to IHT.
A gift with reservation is broadly, a gift of property made by an individual, whereby either the recipient does not enjoy possession of the gifted property, or the donor continues to enjoy or benefit from it.
As your father still lives in the house, the value of the property will be treated as part of his estate for IHT purposes, which would make his estate worth about £750,000. Given that the property is worth £250,000 and his other savings total £500,000, the first £650,000 would be tax free, but IHT would be due on the remaining £100,000.
As a way round this, your father could pay rent at the open market rate to live in the house. And you and your brothers would pay income tax on the rent you receive.
Assuming you don’t claim exemption to the rules on a gift with reservation and your father starts paying you all rent, this will mark the start of a potentially exempt transfer (PET). This means that if your father continues paying market value rent for seven years, then the house will not form part of his estate on his death. If, however, your father pays rent for less than three years, then the house will form part of his estate. Paying rent retrospectively is not an option.
Another possibility is that you may be able to claim exemption to the rules on a gift with reservation if the gift represents reasonable provision for your father’s care and maintenance due to old age, infirmity, etc, and results from unforeseen changes in circumstances, for example a sudden serious illness.
The donee needs to be a relative of the donor or of his spouse or civil partner as you are. The ‘reasonable’ test is subjective, and whether it is met depends on the circumstances, and your father may meet this test.
If the gifts to your father’s sons and grandchildren are gifts out of income, then they will effectively be free of IHT. If they are not and he survives for seven years, then they will be tax-free under the rules of a PET. If your father were to die within seven years, then they will be classed as part of his estate for IHT purposes.