Can I give my adult children my home and put it in trust to avoid a huge inheritance tax bill?

I’m a single parent and so only benefit from one inheritance tax allowance rather than being able to double up as a married couple could.

This means I can only leave £500,000 inheritance tax-free rather than the £1million – like a married couple. 

I want to give my adult son and daughter as much as possible, so could I gift them my home now and put it in trust?

I understand that I could do things like sign the deeds over to them, but would this add financial complications?

What trusts are available to me? What other options are there? L.P, via email

Harvey Dorset, of This is Money, replies: The rules allow spouses and civil partners to pass their own unused inheritance tax allowances to each other upon death, essentially doubling up what they can leave tax-free.

The standard inheritance tax-free allowance for an individual is £325,000, known as the nil rate band. There is a further allowance, the ‘residence nil rate band, which adds up to £175,000 if you leave your home to a direct descendant.

Married couples and civil partners can double these allowances, provided they have not made IHT liable gifts in the seven years before their death.

Trusts are a long-standing popular way to give away assets and beat inheritance tax and are widely used by wealthy families. There has been a surge in interest in trusts as more people are dragged into the inheritance tax net, especially since Rachel Reeves announced pension pots will also soon be included. 

However, many may be surprised to learn a trust is not the catch-all inheritance tax dodge they think. This is a complicated financial area and the rules have been tightened, limiting the amount of control people can retain over assets or benefit they can derive from them, without paying extra tax charges.

You can exert control over how the money might be used, if you choose the right trust. But you usually cannot continue to benefit yourself from what has gone into it, then still expect your beneficiaries to avoid inheritance tax.

To find out what options are available to you, This is Money spoke to two financial advisers.

Lisa Caplan, director of CSD advice & guidance at Charles Stanley, replies: Options for gifting property in your lifetime are limited. Trusts can be useful, but the regulations around them have made them less useful for minimising inheritance tax (IHT). Your position differs if the property you are thinking of giving to your children is your own home, where you live, or if it is it another property or properties.

There are a series of ‘gift with reservation’ rules, which make it difficult to make a gift (even to a trust) of your home, if you continue to live in it.

However, you may be exempt from this if you:

• Continue to live in the property but pay full market rent to your children

• Jointly occupy the house with the recipients and continue to pay your fair share of the household expenses.

In addition, be aware transferring your home may impact the ability of your executors to claim the residence nil rate band of £175,000 for IHT on your estate, especially if it is held by a trust.

If it’s not your home, it can be much more straightforward so long as you are prepared to lose control of the asset. Transferring a holiday or rental property to your children is a gift and becomes exempt from IHT after seven years. Rental income would go to the children and be taxed accordingly, and if you use the holiday home, you should pay them the market rate.

Also keep capital gains tax in mind. It is payable by you on the profit you have made on the property other than your home at the point you make the gift. This is at either 18 per cent or 24 per cent or a combination of both depending on whether you are a basic or higher rate taxpayer.

Trusts can be useful in mitigating inheritance tax, but they can be complicated and costly. The most commonly used is a discretionary trust.

A trust is a legal structure that will have at least three components:

1. The settlor, the person gifting the property to the trust;

2. The trustees who administer the trust and have discretion about who it pays out to;

3. Beneficiaries, who are ultimately entitled to the assets.

There are legal costs involved in setting up a trust, and the trustees are required to register the trust with HMRC and complete regular tax returns for it. There may be regular reporting requirements and possible IHT payments on the trust’s ten-year anniversary and when payments are made to the trust’s beneficiaries.

Transfers to a trust are usually regarded as Chargeable lifetime transfers (CLTs) which are subject to IHT when they’re made, but they won’t always result in a tax liability. This is because you can use your nil rate band allowance of £325,000 to reduce the amount of tax payable. Gifts above this amount are taxed at 20 per cent.

Using your nil rate band for this means it will not be available for other gifts or CLTs made in the next seven years. If you die within the next seven years IHT will be recalculated at the death rate and your estate will be liable for the difference.

If you live for another seven years, there is no further tax liability, and your £325,000 allowance becomes available once more. You cannot reclaim the 20 per cent already paid.

One other option is to set up a company that owns the property and you and your children would own shares in it. This can be useful tool for property investors, but like with trusts, there are legal and administrative costs, and tax reporting as well. There may also be capital gains tax on transfer of the property into the company.

Chris Peters, independent financial adviser at Flying Colours, replies: As you may be aware, your IHT allowance is £500,000, provided that your estate does not exceed £2million. This is made up of £325,000 nil rate band (NRB) and £175,000 residence nil rate band (RNRB). Any assets in your estate above this amount will be subject to a 40 per cent IHT tax rate. For the purposes of this piece, I am assuming your estate exceeds £500,000 but not £2million.

The right option depends on personal circumstances and the desired outcomes to reduce any potential IHT liability.

Being a single parent and owning the property solely means a property protection trust is not suitable for you; this is primarily designed for couples or individuals who jointly own a property.

However, you could consider other trusts or gift all or a proportion of the property to the children. Some trust arrangements might allow you to live in the property rent-free, while others would require you to pay rent at the market value.

A further consideration is that the money you use to pay rent would be from your own taxable income, and the trustees would also have to pay 45 per cent tax on the income going into the trust – effectively, it would incur tax twice.

You would also need to make sure that the trust was set up to go straight to direct descendants to retain its RNRB classification.

Giting into a discretionary trust, this would be treated as a chargeable lifetime transfer (CLT). A CLT is a gift made during an individual’s lifetime, which is immediately chargeable to IHT. This does not necessarily mean that there will be IHT to pay but it will be assessed to see if a charge will arise.

If the gift is within the available NRB, then there will be no IHT due immediately. If the gift is above the NRB, then the charge applied is at the lifetime rate of 20 per cent. However, if you die within seven years of making a CLT, it will be brought into the IHT calculation and tax will be recalculated at the full rate of 40 per cent.

Discretionary trusts may be subject to periodic charges up to six per cent every 10 years (if above the £325,000 trust NRB) and when capital is paid out. The transfer of assets into and out of the trust will be a disposal for capital gains tax (CGT) purposes. The trust rate for capital gains is 24 per cent for residential property. So, there is a lot of consideration required before deciding that a discretionary trust is the right solution for you.

The alternative option is to use a deed of gift, where you legally pass all or part of the property to your children without any payment or exchange in return. This process exempts the recipients from paying stamp duty, CGT or income tax on the property value. Gifts are considered potentially exempt transfers (PETs). If you survive for seven years, the gift is exempt, but if you die it might still be included in your estate for IHT calculations. If you gift more than £500,000 (NRB plus your RNRB) within seven years, the excess amount may be subject to IHT, either immediately (if it’s a chargeable lifetime transfer) or when you die.

For a gift to be recognised by HMRC, you must give away full ownership and benefit. If you continue to reside in the property without paying full market rent, it’s classed as a ‘gift with reservation of benefit’.

This means that for IHT purposes, HMRC will treat the house as still belonging to you, even though it’s legally in someone else’s name. The property value will be added back into your estate upon death and will be taxable.

To avoid this, you must to pay rent at the market value to your children when you gift the property and prove you no longer benefit from the property in any way.

Gifting your home might reduce your IHT bill, but it can also raise other complications:

If you gift your house and later apply for means-tested care, your local authority may investigate your financial history. If they believe the gift was made to reduce your assets and qualify for support, they can treat it as a ‘deprivation of assets’.

In this case, the council could still include the value of the home in their financial assessment, meaning you’d be expected to pay for your care as if you still owned the property. This applies regardless of how many years have passed since the gift was made, as there is no fixed time limit on the deprivation of assets rules.

If care fees are a potential concern, it’s especially important to weigh up whether gifting your home is the right move.

Other potential solutions lie in using your will to set up a flexible trust on death (bypass trust), especially if you want to protect assets for grandchildren, or if your children have complicated circumstances, such as second marriages.

You could also downsize and gift the proceeds – although you would need to survive seven years for the gift to fall outside your estate for IHT purposes.

You could also use equity release and/or invest in a business relief (BR) scheme. However, BR is a higher risk strategy but could reduce the IHT timeframe from seven to two years. This strategy limits the equity you can release from your property and potentially would not remove the full IHT liability, but could reduce it. BR is only suitable for individuals who have higher risk profiles and sufficient capacity to absorb any financial losses.

I would advise you seek independent professional advice to guide you through this process, as IHT and Trusts are a notoriously complex area.