07 November 2016
How to mitigate Inheritance Tax on a holiday home
As a recap, the Inheritance Tax (IHT) threshold is £325,000, and with the ability to transfer your unused IHT threshold to your spouse if they outlive you, this gives an effective IHT threshold of £650,000 for most married couples.
Where your estate (i.e., home, other properties, savings, investments etc) exceeds the IHT threshold, then your beneficiaries will face 40% tax on any value above that level.
So, what steps can be taken to mitigate future IHT liabilities for your loved ones? One of the simplest things you can consider is to gift assets during your lifetime. Providing you survive for 7 years from the date of the gift then it will fall outside of your estate for IHT purposes. Even if you don’t survive for 7 years, a taper relief kicks in providing you survive at least 3 years which reduces the value of the gift on which IHT will apply, meaning that lifetime gifts are often an effective way to mitigate future IHT liabilities.
However, complex rules apply where you gift an asset that you continue to derive some benefit from. This is known as ‘reservation of benefit’ and has the effect of keeping the asset within your estate for IHT purposes until you cease to benefit from using it. As a result, gifting such assets during your lifetime will often be ineffective in reducing IHT liabilities.
If we consider a holiday home, then there are two ways to gift them to the next generation which avoid the reservation of benefit rules and are therefore effective in terms of planning to mitigate IHT, as follows:
- Gift the entire property and then pay the beneficiaries of the gift a market value rent each time you stay in the property (if you stay for the odd night with the beneficiaries then no rent will be necessary, but it would be if you use it when the beneficiaries are not there).
- Gift part of the property and then continue to pay your share of the running costs for the part retained.
Option 1 has the advantage that the whole property has left your estate for IHT purposes (once the 7 year period has elapsed), so is potentially the best outcome in terms of reducing IHT. However, it means that you have to shell out each time you use the property which, while itself quite effective in reducing the value of your estate for IHT purposes, may not sit comfortably with some people. Also, your children (or other beneficiaries) will have to account for income tax on any rents you pay them.
Option 2 is often the preferred solution as you achieve a partial IHT saving (once the 7 year period has elapsed) but without having to pay rent which keeps things much simpler. However, you would have to be able to demonstrate to HMRC that all owners can make use of the property and pay their share of the running costs. This is often best achieved by setting up a joint bank account which is used to meet property expenses.
What else do you need to consider? Gifting a holiday home to the next generation will trigger a Capital Gains Tax charge based on its current market value and we therefore recommend seeking advice on this before any gift is made. There are often ways to mitigate Capital Gains Tax with careful planning.
The above looks at one type of asset, but when planning for Inheritance Tax it is important to consider all assets in your estate as there may well be simpler ways to achieve IHT savings.
For more advice on this matter, or Inheritance Tax generally, then please contact me.
- Gifting a holiday home to your kids won’t save Inheritance Tax if you continue to use it
- You could gift the whole property and then pay a market value rent when you use it
- However this will have income tax implications for your children
- Another option is to gift part of the property to your children
- This is effective if you can all use the property and all pay your share of running costs