Q&A: Have I set up my children for a tax double-whammy?

Q: A few years ago I gifted my children my house - but now I’m worried I may be leaving them with a large tax bill.

I’m in my 70s and I live alone as my husband passed away in 2015. Shortly after, I decided to gift my house to my children for two reasons. First, I wanted them to benefit from my assets on my passing away, but I also wanted to protect them from paying Inheritance Tax.

In 2016, all paperwork was signed, but in hindsight, I think I’ve made a mistake.

I continue to live in the house, but, while trying to navigate Inheritance Tax, I think my children will instead be stung for Capital Gains Tax when my property is sold. Is there anything I can do to limit their tax bill?

A: Sadly, your property may be subject to both and it is crucial you consider your next steps carefully.

Your actions were well meant. With Inheritance Tax (IHT) bills soaring, it’s easy to see why we would want to protect our children, and our assets, from being pulled from beneath us.

As you are still living in the house, your gift will count as a “gift with reservation” - which means it will still be included in your estate for IHT purposes when you pass away.

If you’d have left it in your own name, there's a chance your children could have inherited it tax free.

When passing on your family home to direct descendants - children, stepchildren or grandchildren - they benefit from what’s called a Residence Nil Rate Band (RNRB) threshold, which is £175,000 per individual. For married couples, this band can be combined to £350,000. In addition to the RNRB, each individual is entitled to the Nil Rate Band (NRB) threshold of £325,000. Therefore, for married couples, the combined band is £650,000. Consequently, with the two bands (RNRB and NRB) the maximum threshold is £1M.

Therefore, by leaving your home in your name, your children would benefit from that RNRB threshold which could reduce their tax bill significantly.

Unfortunately by trying to help your children, you may have hindered them.

As your property is not your children’s main residence, not only will your children pay IHT, you’re quite right, they could also be subject to a Capital Gains Tax (CGT) bill if they sell the property. Property prices have increased a fair bit since 2016, so they would be liable for a bill for the increase in value since 2016 as that is when the gift is deemed to have taken place.

How to improve your situation

As yours is a gift with reservation, the rules state that you must give away all the benefits of the asset in order for it to be excluded when you die. You don’t state whether or not you pay rent, but if you don’t, it’s worth considering paying a market rent to your children, which would deem it a potentially exempt transfer from the date that rent is paid - but you would need to live for a further seven years after that.

This is easier said than done as you will need to go through regular rent reviews in the usual way that any other renter would. Your children would also have to pay tax on the rental income - so it may no longer seem feasible if you were trying to save them from the tax bill in the first place.

Let us help

It can be tempting to take on legal affairs yourself, but there are many ways we see people come unstuck. It’s best to seek advice when it comes to these things as it can have drastic consequences.

If you are in a similar situation, contact the Private Client team at Downs Solicitors to see how we can help.