Many middle-class parents have seen the capital value of their main residence appreciate sharply over the years leading to a potential inheritance tax liability on death.
As a result, to remove the main residence from their death estate, they may choose to make a lifetime gift but reserve the right to live in the property until they die.
This is called a gift with reservation of benefit and is initially treated as a potentially exempt transfer (PET) that is only taxable if the donor dies within 7 years of the gift.
As the donor is enjoying the benefits of ownership despite relinquishing legal title to the asset, the asset is included in the donor’s death estate based on the market value at death.
Should the donor die within 7 years of the PET, the same asset is taxed twice -as a taxable PET and being included in the death estate.
HMRC offer double charges relief and only require the donee to pay the higher of lifetime tax and tax based on the death estate.
To avoid the gift with reservation rules, the donor must pay market rent for occupation of the property.
Dilip is a widower and lives in a large house worth £3 million. He decides to gift the property to his daughter Meera and reserve the right to live in the property rent free until death.
Dilip dies 5 years later and on death the property is worth £5million.
The market rental value of the property is £50,000 a year.
As Dilip is living in the property rent-free at death, the property value of £5M is included in his death estate. Double charges relief is available to Meera so she must pay the higher of lifetime tax based on the PET of £3M and the death tax based on £5M.
Had Dilip paid Meera £50,000 rent for the use of the property, it would not be included in Dilip’s death estate and only the £3M would be taxable.
Let’s say Dilip moved out of the property after 4 years into a retirement home and at that point the property was worth £4M.
Here the property will not be included in Dilip’s death estate as he is not occupying it at the date of death.
However, when he leaves the property this creates a second deemed PET worth £4M . No annual exemption of £3,000 is available here.
Double charges relief is available to Meera so she mut pay the higher of lifetime tax based on the PET of £3M and the second deemed PET of £4M.
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