We are often asked by clients who are considering buying a holiday home whether they should buy it in their own names or in the names of their children. We are also asked by clients who already have a holiday home whether they can reduce their inheritance tax bill by gifting the property to their children or putting it into the joint names of them and their children. So what are the tax implications? Many clients think only in terms of inheritance tax, but income tax, capital gains tax and stamp duty land tax also need to be considered.
Key tax issues
- Inheritance tax (IHT) - Gifts of this type can very easily fall foul of the gift with reservation of benefit (GROB) rules. These rules mean that if an individual continues to use, or benefit from, an asset after they have given it away, then HMRC views the individual as not really having made the gift at all, so that the whole value of the gift remains subject to the IHT regime and potentially chargeable to IHT in their estate
- Income tax (IT) - Even if a gift successfully avoids the GROB rules, it can be caught by the pre-owned asset tax (POAT) rules and lead to an unwanted annual IT bill
- Capital gains tax (CGT) - The gift of a property, or of a share in it, is treated as a sale at its open market value for CGT purposes, so there could also be a CGT liability. For those buying a holiday home with cash that's not an issue, but those with an existing holiday home need to consider the amount of the gain from the date of acquisition and the date of the gift
- Stamp duty land tax (SDLT) - There can also be SDLT implications for the recipients of the gift.
Angela and Barry are a married couple in their 60s. They have two adult children, Christine and David, who are each married with young children. Angela and Barry have recently purchased a holiday home in Cornwall for £1,000,000 and would like to give all or part of it to their children to mitigate IHT. It is intended that the holiday home will be available for use by all the family and not let commercially.
Inheritance tax and income tax
It is possible to avoid the GROB (and POAT) rules by making sure that the gift falls within a specific exemption to the IHT rules (known as the 'co-ownership exemption'). This applies when one or more people (the Donors) make a gift to one or more other people (the Donees) of a share in a property and:
- The Donors and the Donees both 'occupy' the property
- The Donors don't receive any benefit, other than a negligible one, from the Donees for some reason connected with the gift.
So if Angela and Barry give a 25% share to each of Christine and David, this would potentially fall within the co-ownership exemption. If it does fall within the exemption, the POAT rules don't apply either.
This sort of planning isn’t considered by HMRC as aggressive planning unless the percentage of the property given away is excessive. HMRC's guidance is that any gift of more than an equal share will be routinely investigated.
To ensure that the gift falls within the co-ownership exemption, Christine and David must 'occupy' the property as well as their parents. Whilst the term 'occupy' is not defined in the legislation, it is clear that this does not mean that Christine and David need to live in the property as their main residence. They would, however, each need to have free access to the property, for example they would each need to have their own key and to leave some of their own things at the property on a permanent basis. The property paperwork should also reflect the new joint ownership arrangement including notifying the local authority for council tax and the insurer of the building and its contents.
If the co-ownership exemption is met, and Angela and Barry survive the gift by 7 years, the gifts would not be subject to IHT on their deaths. If either of them do not survive for 7 years, there may be IHT on the gift of their 25% share, depending on what other prior gifts they may have made in their lifetime.
The absence of benefit requirement
It is important to consider how the ongoing costs in relation to the property are going to be met. There is no problem if Angela and Barry continue to pay all the costs – as often happens in families. There can then be no argument that Angela and Barry are receiving any benefit (so long as Christine and David are not in turn paying other bills for their parents unrelated to the property).
If Christine and/or David do make a contribution to the running costs, it is wise to err on the side of caution and for Angela and Barry to still 'overpay' their share of the costs so as to avoid any challenge to the arrangement by HMRC, on the basis that Angela and Barry are in some way deriving a benefit.
Remember, it is essential for this planning to work that the absence of benefit requirement is satisfied throughout the entire time the property is jointly owned, not just for the first 7 years.
Potential future IHT problems
If Christine and/or David cease to occupy the property at any point, the protection of the co-ownership exemption is lost and a reservation of benefit would arise. This means that the value of their share in the property at that point, and which may have increased in value, is brought back into the estates of Angela and Barry for IHT, defeating the planning. This would be the case even after the 7 years has elapsed from the date of the gift.
Capital gains tax
So long as Angela and Barry give a share in the property to Christine and David soon after its purchase, it is unlikely that any CGT liability will arise, even though they may need to report the gift to HMRC. However if Angela and Barry had owned the property for a longer period and it had gone up in value since they had originally bought it, a CGT liability could of course arise, currently at a 28% tax rate.
Stamp duty land tax
Some issues to consider are:
- Giving away a share in a property to someone who doesn't already own a property is likely to prevent them qualifying for the first time buyer's allowance
- If they do not already own a main residence, it is also likely to mean that they will have to pay the additional 3% SDLT charge when they do purchase their main residence. If they already have a main residence and just replace it, then the surcharge will not apply
- Giving away a share in a property with a mortgage can also give rise to an SDLT liability.
Although the above example involves a UK property, there is nothing to prevent the co-ownership exemption from applying to a property abroad, such as in Spain or France. Such gifts would need careful consideration as not only is it necessary to consider the UK tax issues, but also the tax and succession issues in the other country.
Whether your property is in the UK or abroad, further consideration of the tax implications needs to be given if you intend to rent out the property.
As an alternative, Angela and Barry could give away the whole of the property to Christine and David and avoid the GROB rules by paying a full market rent for their use of the property. This can be a good option in the right circumstances, but it may be very expensive both in terms of the outlay of rent (which is then taxed in the children's hands) and in ensuring that adequate evidence of a market rent is obtained on a regular basis.
An outright gift of a share in a family holiday home can, if the conditions are met, be a relatively simple and effective way of reducing the size of your estate for IHT.
But as always don't let the tax tail wag the dog. You will also need to consider what would happen if any of the recipients died before you or got into marital or financial difficulties, or if your own financial circumstances changed. Any form of gifting or planning needs careful thought and sound advice.
This article is provided for general information only and reflects the law at the date of publication. It does not constitute legal, financial, or other professional advice so should not be relied on for any purposes. You should consult a suitably qualified lawyer or other relevant professional on a specific problem or matter. Please see our terms and conditions for further details.