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Gift with reservation of benefit - Inheritance Tax Issues

Our People - Andrew Guile
5 December, 2022

One simple way to try to reduce the inheritance tax payable on your estate upon death is to give parts of your estate away as gifts during your lifetime. However, if you give someone a gift and are seen as having retained or ‘reserved’ some manner of benefit from that gift, then it is likely to still be taxed as part of your estate.

What is a potentially exempt transfer?

When someone dies, their estate is liable to pay inheritance tax on the value of the deceased’s estate on the date of their death. When calculating the value of the estate, the law looks back seven years at any gifts made from the estate to non-exempt beneficiaries. Any gifts made within this seven-year period are known as potentially exempt transfers or PETs and may, wholly or in part, be treated as forming part of the deceased’s estate for tax purposes.

What is a gift with reservation of benefit? 

A gift with reservation occurs where, for example, a parent gifts their home to their children and continues to live in the property. In those circumstances, the parents are said to have reserved a benefit in the gift and, as such, it will be treated as part of their estate on death, even if it was gifted to the children more than seven years prior to their death. 

What counts as a lifetime gift?

Gifts include:

  • Money (cash/bank transfers).
  • Personal property, for example, furniture, jewellery, or antiques.
  • A house, land or buildings.
  • Stocks and shares listed on the London Stock Exchange.
  • Unlisted shares you held for less than 2 years before your death.

A gift can also include someone benefiting from you selling them something for less than it’s worth, e.g., if you sell your house to your child for less than its market value, the difference in value amounts to a gift.  ​

Anything you leave in your will does not count as a lifetime gift but forms part of your estate. Your estate is all your money, property and possessions left when you die. Any Inheritance Tax due is calculated on the value of your estate as at the date of death.

What is the 7-year rule for lifetime gifts?

The ‘7-year rule’ is essentially the law relating to potentially exempt transfers (PETs – see above). If you give a non-exempt beneficiary (examples of exempt beneficiaries are your spouse and charities) a gift during your lifetime and then survive for another 7 years, no inheritance tax is payable on that gift.

Who pays the tax on a gift with reservation?

The person primarily liable to pay tax on the gift with reservation of benefit is the recipient of the gift. The personal representatives (i.e., the executors under a will) of the estate have a secondary liability to pay the tax if it remains unpaid twelve months after death.

How does HMRC know about gifts?

Executors of a will have a legal duty to ask these questions and to include such issues when calculating and reporting the size of the deceased’s estate to HMRC. It is a criminal offence to wilfully or recklessly report the value of an estate knowing that issues such as lifetime gifts, PETs, and gifts with reservation of benefit have either been ignored or have not been investigated at all.

If you have a solicitor helping you administer an estate after someone has died, they will ask questions about lifetime gifts, PETs, and gifts with reservation of benefit. It may be a matter of professional misconduct for them not to do so. However, the legal duty remains with the executors to report the size of the estate accurately to HMRC.

How is Inheritance Tax on a lifetime gift paid?

Any Inheritance Tax due on lifetime gifts given in the 7 years before your death is normally paid by the estate, if the total value of those gifts is no more than the nil rate band as at the date of death (currently £325,000). Once you’ve given away more than your nil rate band, anyone who gets a gift from you in those 7 years will have to pay Inheritance Tax on their gift.

Payment of market rent to avoid a gift with reservation

If, for example, a parent gives their property to their child but continues to live in it, HMRC will often scrutinise those transactions and is likely to conclude that the parent has retained a benefit (bringing the value of the property/gift back into their estate for inheritance tax purposes), unless the parent pays the child a market rent (i.e., not a reduced ‘nominal’ rent).

However, the parent is unlikely to want to do that (and, indeed, may not be able to afford it) and the child will have to pay income tax on the rent receipts. There is no doubt that, if you want to gift your property to your children in your lifetime in the most tax efficient way, you must ensure that you do not reserve any benefit and you need to survive more than 7 years from the date the gift was given.

If you would like any help or advice on a gift with a reservation of benefit, or any issues relating to inheritance tax or probate, please do not hesitate to contact one of specialist Probate Solicitors or get in touch on 020 8492 2290.

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