Is a gift always a gift, or does it come with consequences?
When someone dies, a person’s property and possessions, otherwise known as their estate, may become subject to inheritance tax (IHT). This is the tax payable on a deceased’s estate where the value of that estate exceeds a certain threshold set by the government annually.
By making lifetime gifts to loved ones, it may be possible to reduce the amount of inheritance tax payable on death, in this way maximising how much you can pass on to your friends and family after you die. However, to be effective, where there are no inheritance tax consequences arising from making a gift, it must meet certain strict criteria.
In broad terms, gifts fall into three categories: exempt transfers, potentially exempt transfers (or PETs), and chargeable lifetime transfers (or CLTs).
An exempt transfer is a gift that can be made at any time during your lifetime, whose value will be entirely ignored for the purposes of inheritance tax, even if you die shortly after making it. For example, this could include the £3,000 annual exemption that can be gifted to loved ones without this being added to the value of your estate. There are also various other low value exempt gifts that you can make without attracting any IHT.
In contrast, potentially exempt transfers are gifts that will only become fully exempt from inheritance tax if you survive the date you made the gift by a period of 7 years. This is known as the 7-year rule. For a gift made between 3 to 7 years before your death, these will be taxed on a sliding scale known as taper relief. However, for gifts made less than 3 years between the date of the gift and death, these will be taxed at the full applicable IHT rate (currently set at 40% on the value of an estate exceeding the inheritance tax threshold of £325,000).
For those gifts falling within the chargeable lifetime transfer category, this may attract an immediate tax charge, with an additional charge should you then die within 7 years of the gift being made. A gift made into a discretionary trust may be treated as a chargeable transfer, although trusts can still prove to be useful tools as part of your overall tax planning, especially where there are minor beneficiaries.
The rules relating to gifts and the inheritance tax consequences that can flow from this can be complex. Even where something has a loss in value, it can be treated as a gift. For example, if you sold your house to an adult child for less than it is worth, the difference in value will count as a gift. There are also a number of other potential tax traps, or financial catches, that can arise when making a gift during your lifetime, including the following:
- reservation of benefit: where you gift an asset but continue to derive a benefit from it, like giving away your house but continuing to live there, you may be treated as still owning it for inheritance tax purposes, even if the gift was made more than 7 years before your death;
- deprivation of assets: where you gift an asset but subsequently require nursing care, you may be treated as still owning that asset for the purpose of the financial assessment undertaken by the local authority to determine your contribution to the cost of your care;
- capital gains tax liability: where you gift certain assets, such as shares or a second home, this may be treated as a disposal for capital gains tax purposes, where you may be liable to an immediate charge to tax if the asset’s value has increased since it was acquired.
It is important to always seek specialist legal advice when gifting money or giving away assets during your lifetime for the purposes of avoiding inheritance tax after you die. This can require careful estate planning and expert knowledge of the law.
For expert advice on Wills, Trusts and Inheritance Tax please call 01282 695400 or click here to email.
The matters contained herein are intended to be for general information purposes only. This blog does not constitute legal advice, nor is it a complete or authoritative statement of the law in England and Wales and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its’ accuracy, and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should always be sought.