Q. I provided funds to my two children for the purchase of a property that our family can use for vacations and weekends. I am responsible for most of the expenses related to the property’s maintenance. If my children permit me to live there rent-free during my retirement, will there be any tax repercussions? Marion, 67
Transferring money to family members to assist in property purchases is quite prevalent. However, if the original owner continues to utilize the property, it may introduce complexities related to inheritance tax (IHT).
For monetary gifts to be excluded from your estate for IHT considerations, the giver typically needs to survive for seven years post-gift. If death occurs within three years, the gift is included in the estate for IHT, which may incur a tax rate of 40 percent. If death happens between three and seven years later, the tax rate will vary from 32 to 8 percent on a sliding scale.
Nevertheless, to completely remove a gift from an estate for IHT, the giver should not retain any interest in the asset. Failing to do so may classify the asset as a “gift with reservation of benefit” or subject it to a pre-owned assets (POA) charge.
This situation typically arises when someone gives away an asset but continues to gain benefits from it. For instance, if you gift your home but keep living in it rent-free, the property will still count within your estate for IHT calculations.
The POA charge was enacted to prevent tax avoidance strategies aimed at bypassing the gift with reservation rules. This charge may be applied if a person indirectly or directly benefits from a previously owned asset. Here, since you provided funds to your children for a property you intend to occupy without rental payment, the POA charge might come into play. This charge acts as an annual income tax on the benefit derived from the asset you once owned.
The POA charge is determined by the market value of the rent for the space you inhabit. Living in the house without paying rent would subject you to liability equivalent to the market rent. To avoid the anti-avoidance rules, you could opt to pay your children a market rate rent, which would enable the property to remain outside your estate for IHT purposes. However, you should consider if this is financially feasible. Additionally, it could generate a tax liability for your children as the rental income would be taxable.
Generally, a gift is not subjected to anti-avoidance regulations when the recipient’s usage of the gift is incidental. For instance, if you are residing in the property only while your children or grandchildren are using it for family getaways, it’s possible that this arrangement may not incur a POA charge.
If the situation were to evolve into you taking up permanent residence in the property, the anti-avoidance rules would likely be enforced. As an alternative to incurring the POA charge, you might opt for the property to be classified as a gift with reservation of benefit, which would make it liable for IHT as part of your estate upon your passing.
Kate Aitchison is an expert in capital gains tax, inheritance tax, succession planning, investment structuring, and tax residency at RSM UK.