Is there a way to avoid paying IHT on our family home?

Like most old houses in our area, the value of our home has skyrocketed over the last 25 years. We now worry that our cherised family home house will present our two children with a nasty inheritance tax bill. Is there anything we can do that won’t cost an arm and a leg?

Question asked by Henry Shaheen
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Answered by Stephen Moore

Currently you and your spouse enjoy a joint inheritance tax allowance, or nil-rate band, of £650,000. At the start of the 2017 tax year, all UK residents will also qualify for the new main residence allowance which starts at £100,000 per person. It’s scheduled to rise incrementally in each of the following three tax years and to reach £175,000 by the 2020 tax year, when it will then rise in line with consumer price inflation (CPI).

This means that by April of 2020, you and your spouse will enjoy a combined inheritance tax allowance of £1 million which can be offset against your property before any inheritance tax is due.

Although this sounds generous, it may not be sufficient to spare your estate from inheritance tax – especially as your allowance will also be required to cover the value of any other assets you may have. This means you need to plan carefully to reduce the potential tax bill you pass along to your children. There are a number of simple things you can do before considering more complex arrangements.

How to avoid inheritance tax on your family home?

First you need to decide whether it’s the family home itself that you want to leave to your children or just the value that it has come to represent. Given a few years to plan, it will be easier to pass along the value locked up in your home if it’s been turned into cash. So you need to balance the benefits of a sale against your own needs in the coming years.

If you’re more concerned with passing the value, rather than the property itself, equity release may be an attractive option. With interest rates at record lows, you can now borrow cheaply against the value of your home and release capital that can either be distributed to your beneficiaries or invested outside of the IHT regime for their future benefit.

This approach means that the house will inevitably be sold but that you and your spouse can remain resident in the property until you both die.

Make use of IHT exempt gifts

There are detailed rules around giving gifts that reduce the size of your estate for IHT purposes. HMRC allows you and your spouse an ‘annual exemption’ of £3,000. You can also make a host of smaller gifts each year as well as being able to help support family members or to make regular payments from excess income, all free of inheritance tax.

These are valuable exemptions as they can help to reduce the value of your estate and so cut down the amount of IHT that it inevitably attracts.

Gifting your property to your children to avoid IHT

The next option might be to consider gifting the family home to your children. However, there are a number of drawbacks to this approach not least of which are the complex rules that surround such arrangements.

For example, if you gift your home to your children but you continue to live there, it will remain part of your estate and so be liable to IHT when you die – regardless of when you may have made the gift. To avoid this, you’ll need to pay a market rent and your share of the bills, although any rent you pay will be subject to income tax for your children. You’ll also need to live the prerequisite seven years.

However, in principle, you may be able to avoid inheritance tax and the need to pay rent in situations where you gift part of your property to your children and they subsequently live in the house itself.

Related issues

The other issue is how well you get on with your children and their spouses. If you choose to sign over your property to them it naturally becomes their asset. If relations deteriorate or if, for example, your children then divorce, you could find the house being sold out from under you. Equally, your property could become subject to a bankruptcy settlement for your children.

If you should outlive your children, then you could find yourself living in a property that’s now owned by their beneficiaries.

Capital gains tax

The issue is further complicated by the risk of capital gains tax (CGT). If you gift your property to your children, as it won’t be their main residence, any gains above the £11,100 annual allowance will be subject to 18% tax for basic-rate tax payers and 28 per cent for higher rate tax payers. By contrast, there’s no CGT liability on cash gifts.

Remember to include potential care costs when making your plans. Local councils have the power to reverse any transfer of ownership if they deem that the transfer was a “deliberate deprivation of assets” calculated to avoid residential care home fees.

None of this is straightforward so always seek professional advice and keep in mind that, the sooner you start making arrangements, the more likely you are to be able to avoid inheritance tax altogether.

inheritance tax
main residence nil rate band
family inheritance tax liability
This information does not constitute financial or other professional advice. You should consult your professional adviser or contact us directly on 02084327333 should you require financial advice. It is important to ensure any insurance policy you take out is suitable for your needs.
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