In this article we look at the technical aspects of PETs and GROB, our next article will focus on how effective estate planning will help ensure allowances are maximised.
When people think of the future and their loved ones, many wish to give a lifetime gift (cash or assets) to family or friends at some point in their lifetime. People might be motivated to make the gift because the beneficiary is in need of money (e.g. to help them purchase a property, or to reduce financial hardship), or for inheritance tax planning reasons.
A lifetime gift is described as a Potentially Exempt Transfer (or PET ).
However, the situation becomes slightly more complicated where the person making the gift continues to enjoy a benefit from it. Special rules were introduced to prevent people from avoiding inheritance tax by giving away their property, without at the same time relinquishing the use or benefit they previously enjoyed from it. This becomes a Gift with Reservation of Benefit.
What is a gift with reservation of benefit?
A gift with reservation of benefit (GROB) is where a person has made a gift during their lifetime but retained some use or benefit of the gift. For example, a person may gift their home to their children but continue to live in the property.
In the situation where a person makes a lifetime gift but continues to enjoy the property which has been given away, the gift does not leave the estate for inheritance tax purposes. The most common situation in which this occurs is where a parent gifts their home to their children but continues to live in it until death. Tax laws generally seek to tax individuals based on beneficial rather than legal ownership. In this example, the legal title of the property has transferred but the ability to benefit from the property has not transferred. This occurs even if there is no contractual right to live in the property. If an individual has benefited from a property, in this example by living in it, that person is taxed as beneficially owning the property.
Potentially Exempt Transfer (PET)
If a gift was made and they retained the benefit for a period of time but then subsequently gave it away absolutely, it will be treated as if a 'Potentially Exempt Transfer' (PET) had been made on the date that the benefit ceased. For example, someone gifted their property and continued living in it for a time but then moved out and stopped benefitting from it. From this point it is not a GROB but will be seen as a true gift, i.e. a PET, and the '7 year rule' applies.
If someone dies within 7 years of making the PET, the value of the gift will form part of their Estate for Inheritance tax purposes. Conversely, if they survive for 7 years from the date of the PET, it would be exempt from Inheritance Tax and would not need to be included as part of their Estate.
What are the rules concerning gifts with reservation?
When, on the date of the transferor’s death, a gift is subject to reservation, the value of that gift will be treated as part of their estate for inheritance tax purposes. It will be treated as if the gift was never made, notwithstanding legal ownership may have passed from the deceased to the beneficiary during their lifetime. However, the deceased may only have continued to enjoy a benefit in the asset gifted for a limited period, and if the reservation ceased more than seven years before the transferor's death, the gift will qualify as an exempt transfer.
Paying rent while living in a gifted property
It is possible to demonstrate that you no longer reserved a benefit in a gifted asset, even though you may continue to use it after the date the gift is made. For example, you might enter into an agreement with the beneficiary to pay them rent for the ongoing use of the asset.
Provided the donor pays a full market rent for the property that he or she used to own, a gift with reservation has not occurred. This is rarely practical because it requires a donor to first give away their home and having received no cash in return to make rental payment for their continued enjoyment. A further drawback is that the recipient, usually one of the transferor’s children, will be subject to tax on the rental income. Given that a person tends to be subject to tax at a higher rate during working life than in retirement, this approach will rarely save tax for the family
The gift of the property will be regarded as a PET. The gift has the potential to be exempt if the donor survives seven years from the date of transferring the property. It is a requirement for the rent to be reviewed at least every five years to ensure that it is still at a market rate. Rental payments provide a mechanism through which the donor could avoid inheritance tax on cash through a series of lifetime rental payments. Income tax payable by the beneficiary on the cash could be less than as inheritance tax on the same amount. This could be especially tax efficient where the beneficiary has unused personal allowance.
Sharing accommodation to avoid gift with reservation
Making a gift of part of the family home in which each owner occupies only their space might be impractical and/or undesirable. An alternative method of avoid the gift with reservation regulation is for the donor and donee to co-habit. Provided that donor pays a reasonable share of household expenses the transfer will be treated as an outright gift. The amount gifted is the property share conferred upon the co-habitee.
Where the donor does not pay their share of household expenses, the donor would be treated as benefiting from the whole property and therefore not making a gift. The donor is receiving something in return and has therefore not made a gift.
Where the donee does not keep up a share of household expenses, there could be a practical issue in demonstrating that the donee lived in the property.
In order for the transfers to be regarded as a gift, each co-owner must pay their share of the upkeep and outgoings associated with the property.
Shared ownership of a property can be achieved either as joint tenant or tenant in common. Using the example of a couple with equal shares, as joint tenants, each owner has a 50% share of the whole property. By contrast, each tenant-in-common owns 100% of one half of the property. An arrangement in which the property is shared as tenants in common would clarify for inheritance tax purposes that a distinguishable gift has been made.
Unless specifically arranged most sharers are joint tenants. The surviving spouse of a married couple automatically acquires his or her share of the jointly owned property by right of survivorship. A tenant in common arrangement provides a simpler method for the deceased to gift their share to someone other than the co-owner.
It may be surprising to know that the gifts with reservation rules also apply to properties owned abroad. For example, if a UK domiciled person gifts a foreign property to their child, but continues to use it as a holiday home free of charge, the whole value of the property will be chargeable to IHT.
Pre-owned asset income tax charge
Other anti-avoidance rules exist to prevent gifts being made to fund the purchase of new assets from which the donor derives a benefit. When a parent makes a gift of cash towards the purchase of a property, if they benefit from the property, they may be subject to a charge even where they have never been the owner of the property.
‘Pre-owned assets tax’ (POAT) applies where a person removes an asset from their estate but continues to enjoy a benefit from it, and the gift with reservation rules do not apply. The person will be liable to pay income tax on the benefit the person receives from using the asset.
For example, where a parent provides cash for their child to buy a home, and this home includes a ‘granny flat’. If the donor lives in this part of the property, this will result in a POAT charge. If an individual fails to pay POAT in their lifetime, the family may find tax, interest, and even penalties are owed upon death.
Associated operations and pre-owned assets
HMRC will seek to enforce gift with reservation rules where linked transactions cause an outcome comparable to a straightforward gift with reservation. Commonly this occurs where proceeds from a property are gifted to the beneficiaries (usually children) of the deceased. The proceeds are used to purchase a property which the original door lives in free of rent. The donor is regarded as being able to enjoy the benefit of a pre-owned asset and subject to tax.
Home loans, double trust and other schemes have been used to sidestep Gift with Reservation rules. Most of these have been legislated against under various anti-avoidance provisions.
Giving away a share of the home to avoid gift with reservation
Giving away part of the family home would suit someone who wants to continue living in their home but also wishes to enrich his or her heirs while avoiding inheritance tax. A part disposal of the home is treated as a potentially exempt transfer. Provided the transferor survives seven years there would be no tax on that part of the gift. A gift with reservation has not arisen because the transferor does not enjoy the share of the property which has been given away.
The gift with reservation rules are only avoided where the gift is unconditional and each party occupies their respective share of the property. The enjoyment by the former occupant of the part of the property given away must be negligible to avoid the gift as being regarded as reserved for tax purposes.
Occupation due to illness is not a gift with reservation
By concession, HMRC will not treat a gift as reserved where the property is occupied due to infirmity of the donor. The following conditions need to be met for the exemption to apply:
- The donor is no longer able to take care of himself or herself due to old age or infirmity;
- The circumstances of being dependent were unforeseen at the date of the original gift of the property;
- The recipient of the gift is a relative of the donor.
The exemption would cover a situation where a parent returns to the former home to be cared for by the child who was previously gifted the property. The exemption does not cover a situation where a parent is already in need of home care at the date of the gift. This could not be reasonably regarded as ‘unforeseen’.
Sadly, by the time a person requires live-in home care their remaining life is often limited. Gifting property at that late stage is unlikely to avoid inheritance tax because of the requirement to survive seven years. A lifetime gift that does not avoid inheritance tax is described as a failed PET. A formal agreement to re-occupy the former home following serious illness would fall foul of the gift with reservation restriction because the gift was not unconditional. However, an informal understanding could suit the needs of both parties. Where the children have agreed to care, it could be more practical for the older infirmed individual to move premises. The children could have work and minor children, and their home could be larger and/or better positioned for medical care.
GROBs and Care Home fees
We often see examples during Probate of a GROB being used to try to prevent a property being considered as an asset by the Local Authority for care fees. However this may be unsuccessful and Local Authorities do have the power to recover care fees, should they feel that assets have been gifted for the purposes of avoiding paying these.
After someone dies, the Executor or Administrator of their Estate is responsible for identifying PETs or GROBs and including these in Inheritance Tax calculations where applicable. If a client is in this position and are unsure of the process, just contact our team as Probate specialists who can give professional guidance and help.
Effective estate planning can be key to ensuring how to manage gifts effectively and tax efficiently. Just call the team for more advice and look out for our next article.