Your father left the whole of his estate, mainly consisting of his share in their home, to your mother in his will. As a result, there will be a big inheritance tax bill waiting when she dies. What steps can you take to reduce it?
Nil rate bands
While the inheritance tax (IHT) nil rate bands (NRBs) do look generous, rising property values are increasing the chances of a large IHT bill.
Currently, if an estate is worth more than £325,000, IHT at 40% is payable on the excess. Plus, there’s an additional NRB of £175,000 where an estate includes a property (or value derived from a property) which was the deceased’s home. For estates worth more which include a residential property further planning is possible to reduce IHT.
Tactics for tax-saving
Basic IHT planning involves making gifts out of your estate and surviving at least four years, but ideally seven as the gift then escapes IHT.
This tactic is not easy to put into practice if a large part of the estate’s value is tied up in the individual’s home. One option is to downsize to release cash to give away. However, where moving home isn’t suitable there are alternatives, but these do require care if the anti-avoidance rules are to be worked around.
The gift with reservation of benefit (GROB) rules
The GROB anti-avoidance rules mean that if you give away an asset but continue to use or obtain a benefit from it, it remains part of your estate for IHT purposes. For example, if your parent transferred ownership of their home to you and continued to live in it. Only when they cease to do so will it count as a gift for IHT purposes.
The GROB rules don’t apply if the transferor pays the transferee rent (at the market rate) for use of the asset they gave away. This can work especially well as an IHT-saving mechanism because the rent the transferor pays also reduces their estate without the seven-year wait.
The problem with the advice above is that the rent is taxable income for the recipient. If they pay tax at basic rate (20%) or less this type of gift and rent arrangement still saves tax overall but is less effective than a plan which avoids tax altogether.
An alternative arrangement is for the owner to give away a share of the property and for the transferee to occupy the property with them. The running costs of the property must also be shared. Moving in with an elderly relative might seem like a drastic move but saving tens of thousands in IHT is a powerful motivator.
Relaxed living arrangements
The transferor and transferee don’t need to live in each other’s pockets. There only needs to be some shared occupation. For example, the home could be divided into different living areas so that the transferee and transferor could largely live apart.
If the property is large enough to be divided into two separate residences and the transferor only occupies one, this would allow them to give away the other residence without the GROB rules applying. However, if they visited the other residence, say because they gave it to a relative, the amount of time spent in the property must be minimal or HMRC might argue that the GROB rules apply.
Your mother could sell the property and give away the excess proceeds to reduce her estate. Alternatively, she could transfer all or part of the property to you and pay rent for the right to continue living it. If relocation isn’t feasible or your mother doesn’t have the funds to pay rent, sharing occupation of the property also works.
Brona MacDougall, Tax Partner