With house prices consistently rising, you may have considered gifts to your children to help them get on the property ladder. Although generous, without proper planning, gifts of any kind can lead to future complications and potentially unexpected tax liabilities.

Potentially Exempt Transfers (PETs)

Gifts in excess of the £3,000 exemption, per donor per year, which are not paid out of surplus income, are known as PETs. This means that if you make a gift, it’s not subject to Inheritance Tax (IHT) provided you (the donor) survive for seven years from the date of the gift.

In the unfortunate event you do not survive for seven years, the original gift will be subject to IHT at a rate of 40%. However, the Nil Rate Band (NRB) of £325,000 can be utilised by such failed PETs in priority to the death estate.

Taper Relief is a tax relief available against any value not covered by the NRB, if you were to pass away and the gift was made more than three years prior to death. This gradually reduces the tax liability by a certain percentage, dependent on how long you survived the gift by.

It’s usually possible to obtain life insurance to protect against the IHT liability resulting from a failed PET, but the cost of such a policy would obviously need to be considered.

Gifts with Reservation of Benefit (GWROB)

It’s also important to consider the rules in respect of GWROB where the gift is in the form of an asset (e.g. a residential property). If you gifted an asset but you continue to derive benefit from the asset, for example by living in a property rent-free, then the property will still fall within your estate, and the failed PET would remain subject to IHT at 40% on death. If the reservation is removed prior to death, for example by ceasing to use the property or by paying a market rent for occupation, then this will be considered a PET from the point the reservation is removed.

Pre-Owned Asset (POA) charges

POA charges should be considered if the gift was by way of cash, which is subsequently used to buy an asset from which you still derive benefit. There will be a continuous Income Tax charge (a POA charge) on you for as long as you still receive this benefit. For example, if you’re living in the property rent-free, but market value rent is £25,000 p/a, you will be taxed to Income Tax on the £25,000. If the original cash gift only provided partial consideration for the purchase of the property, the amount chargeable to Income Tax is apportioned accordingly. You can make an election to be treated as having made a GWROB as opposed to suffering a POA charge, but one or the other will apply so long as a benefit to you is retained.

IHT payment options

If you were to die within seven years of making the gift or removing the reservation of benefit, the failed PET would more often than not give rise to an IHT charge on the recipient. In this instance, the funds will be tied up in bricks and mortar, making it hard for the recipient to pay the IHT. A lifeline is thrown by HMRC in that the recipient can elect to pay the IHT in annual instalments over 10 years (plus interest) where the asset consists of immovable property. If this is still too much of a burden, as a last resort, arrangements can be made to pay the IHT from your estate on death. This would require agreement by all parties involved but it can lead to more complexity as the payment by the personal representatives would be treated as a further gift liable to IHT.

What should you do?

There can be a lot of complications when gifting either cash to buy a property, or a property outright. Both you and the recipient should be aware of potential tax consequences and plan accordingly to ensure that any gifts are made in the most tax efficient way possible. You should also consider seeking financial planning advice, including cashflow modelling to establish if gifting would leave you with enough assets for your own needs.