Inheritance Tax (IHT), Potentially Exempt Transfer (PET) and the 7-Year Rule

HenryThornton

I live in my own freehold home. I want to minimize the inheritance tax when the house is left to my 2 sons on my death. The value of the property today is above my personal allowance. An inheritance tax potentially exempt transfer (PET) requires I pay a market rent to the beneficiaries for the 7 years (assuming I live past then). However, my retirement income and savings are not sufficient to pay a market rent (and bills). Could someone with knowledge or experience please explain how a PET works in practice. Thank-you.

getmore4less

Have you accounted for all transferable and residential nil rate bands?

You will have somewhere between £325k and £1m

AKW

HenryThornton said:

I live in my own freehold home. I want to minimize the inheritance tax when the house is left to my 2 sons on my death. The value of the property today is above my personal allowance. An inheritance tax potentially exempt transfer (PET) requires I pay a market rent to the beneficiaries for the 7 years (assuming I live past then). However, my retirement income and savings are not sufficient to pay a market rent (and bills). Could someone with knowledge or experience please explain how a PET works in practice. Thank-you.

PETs fall outside of your estate for Inheritance Tax purposes if you survive for seven years, otherwise tax is charged on a sliding scale basis known as taper relief. For a death within the first three years, IHT is charged at 40%. The tax payable then reduces by 20% on each anniversary after the third year.
I am not an expert and I don't know if this is a solution, but I will put it forward for discussion: How about gifting half the house to your sons as tenants in common? You then only own half a house. Many people in part ownership pay a small rent for the proportion they don't own. If one of your sons was to move in with you, it could be argued that you only occupy the part you own, and pay no rent at all. 
There are CG and stamp duty implications to consider for your sons, if they are not already home owners. No CG on the gift if this is your main residence, and no stamp duty if you have no mortgage.

Jeremy535897

If you transfer the house you live in to your sons, and continue to live there, the house remains in your estate for inheritance tax, unless you pay a market rent, which you cannot afford, and creates an income tax liability on your sons. A bad idea.

Giving half the house to your sons and arguing that you only need to pay a small rent is most likely going to end up with the same bad result (maybe a little less so).

You become beholden to your children with such plans. What if you need to sell the house to provide for yourself in the future? Relying on the council is a bad idea anyway, but with this sort of "planning", the council would not pay for your care, as they would treat such planning as a "deprivation of assets". What if your children are made bankrupt, or die and their shares in the house pass to someone else?

Before undertaking any sort of planning, check what the inheritance tax liability is likely to be on your death. If you have made no non-exempt gifts in the past seven years, you will have a nil rate band of £325,000 and a residential nil rate band of £175,000. If you are a widower and your wife left everything she had to you, it may be that those figures are doubled.

Keep_pedalling

AKW said:

HenryThornton said:

I live in my own freehold home. I want to minimize the inheritance tax when the house is left to my 2 sons on my death. The value of the property today is above my personal allowance. An inheritance tax potentially exempt transfer (PET) requires I pay a market rent to the beneficiaries for the 7 years (assuming I live past then). However, my retirement income and savings are not sufficient to pay a market rent (and bills). Could someone with knowledge or experience please explain how a PET works in practice. Thank-you.

PETs fall outside of your estate for Inheritance Tax purposes if you survive for seven years, otherwise tax is charged on a sliding scale basis known as taper relief. For a death within the first three years, IHT is charged at 40%. The tax payable then reduces by 20% on each anniversary after the third year.
I am not an expert and I don't know if this is a solution, but I will put it forward for discussion: How about gifting half the house to your sons as tenants in common? You then only own half a house. Many people in part ownership pay a small rent for the proportion they don't own. If one of your sons was to move in with you, it could be argued that you only occupy the part you own, and pay no rent at all. 
There are CG and stamp duty implications to consider for your sons, if they are not already home owners. No CG on the gift if this is your main residence, and no stamp duty if you have no mortgage.

The sliding scale only applies to gifts over the NRB, and even then only to that part of the gift exceeding the NRB.

Giving your home away or even part of it is almost always a terrible idea. No one should put their long term security at risk, and if the people you give your home too run into financial trouble, get divorced or die that is exactly what you are doing.

HenryThornton

Jeremy535897 said:

If you transfer the house you live in to your sons, and continue to live there, the house remains in your estate for inheritance tax, unless you pay a market rent, which you cannot afford, and creates an income tax liability on your sons. A bad idea.

Thank-you. From my research and the comments here the consensus is the 7-year rule PET is not a good idea. If so, who (ie. what kind of person and situation) benefits from the 7-year rule? For example, is it someone who owns 2+ properties in which they live in one and the others are privately or commercially rented - in which case, the house they live in is non-PET but the other properties have a PET? But, the properties with a PET, the beneficiaries will have an income tax liability - yes?

Jeremy535897

HenryThornton said:

Jeremy535897 said:

If you transfer the house you live in to your sons, and continue to live there, the house remains in your estate for inheritance tax, unless you pay a market rent, which you cannot afford, and creates an income tax liability on your sons. A bad idea.

Thank-you. From my research and the comments here the consensus is the 7-year rule PET is not a good idea. If so, who (ie. what kind of person and situation) benefits from the 7-year rule? For example, is it someone who owns 2+ properties in which they live in one and the others are privately or commercially rented - in which case, the house they live in is non-PET but the other properties have a PET? But, the properties with a PET, the beneficiaries will have an income tax liability - yes?

To take your example, if you give away the house you live in, and pay rent, the donee pays tax on the rent, and you get no tax relief. You have effectively created taxable income out of nothing. If you give away a property you rent out, the donee is taxed on the income, but that is instead of you paying tax on it. No extra income is taxed, but there may be capital gains tax on the gift. PETs are best used for cash gifts.

Keep_pedalling

HenryThornton said:

Jeremy535897 said:

If you transfer the house you live in to your sons, and continue to live there, the house remains in your estate for inheritance tax, unless you pay a market rent, which you cannot afford, and creates an income tax liability on your sons. A bad idea.

Thank-you. From my research and the comments here the consensus is the 7-year rule PET is not a good idea. If so, who (ie. what kind of person and situation) benefits from the 7-year rule? For example, is it someone who owns 2+ properties in which they live in one and the others are privately or commercially rented - in which case, the house they live in is non-PET but the other properties have a PET? But, the properties with a PET, the beneficiaries will have an income tax liability - yes?

If all your wealth is tied up in property, then PETs are problematic. In the case you quoted there is the added complication that on transfer of a second property you could be hit with an expensive GGT liability. 

With liquid assets things are far simpler. 

ANGLICANPAT

Of course  everything could become  an 'all change' situation  depending on what the Govt doesnow   to refill its coffers after Covid. Apparently   inheritance tax   is likely to be in the firing line  for massive rejigging   to  lessen the gap between the haves and have nots from the  next generation  going forward (whilst filling the coffers of course) .   The proposals from this outfit  make very interesting reading .   Particularly interesting is  the  idea of   the 'Lifetime receipts tax ' suggestion  which would  prevent the  7yr  give away working  etc   .  It depends of course  not on advisory groups, but what the Govt themselves  decide to do, and most importantly if its  backward or forward dated . 
https://www.resolutionfoundation.org/app/uploads/2018/05/IC-inheritance-tax.pdf

HenryThornton

Jeremy535897 said:

To take your example, if you give away the house you live in, and pay rent, the donee pays tax on the rent, and you get no tax relief. You have effectively created taxable income out of nothing. If you give away a property you rent out, the donee is taxed on the income, but that is instead of you paying tax on it. No extra income is taxed, but there may be capital gains tax on the gift. PETs are best used for cash gifts.

If the 7-year rule for brick & mortar property is not a good idea in practice then why do the HMRC mention it explicitly ie. it must benefit a large group of people or is it a subtle warning "there be dragons"?
This is directly from the HMRC page on passing-on-home under IHT followed by a little clarification in a web-chat:

"""
Giving away a home before you die

There’s normally no Inheritance Tax to pay if you move out and live for another 7 years.
If you want to continue living in your property after giving it away, you’ll need to:
* pay rent to the new owner at the going rate (for similar local rental properties)
* pay your share of the bills
* live there for at least 7 years
You do not have to pay rent to the new owners if both the following apply:
* you only give away part of your property
* the new owners also live at the property
"""
""" If a property is gifted away and the donor continues to live in the property then it is regarded as a gift with reservation and therefore added to the estate. However if market rent is paid from the day it is gifted until death or when they move out of the house then it will be regarded as a gift(PET). The 7 year clock starts from the date the rent started to be paid. """

Jeremy535897

HenryThornton said:

Jeremy535897 said:

To take your example, if you give away the house you live in, and pay rent, the donee pays tax on the rent, and you get no tax relief. You have effectively created taxable income out of nothing. If you give away a property you rent out, the donee is taxed on the income, but that is instead of you paying tax on it. No extra income is taxed, but there may be capital gains tax on the gift. PETs are best used for cash gifts.

If the 7-year rule for brick & mortar property is not a good idea in practice then why do the HMRC mention it explicitly ie. it must benefit a large group of people or is it a subtle warning "there be dragons"?
This is directly from the HMRC page on passing-on-home under IHT followed by a little clarification in a web-chat:

"""
Giving away a home before you die

There’s normally no Inheritance Tax to pay if you move out and live for another 7 years.
If you want to continue living in your property after giving it away, you’ll need to:
* pay rent to the new owner at the going rate (for similar local rental properties)
* pay your share of the bills
* live there for at least 7 years
You do not have to pay rent to the new owners if both the following apply:
* you only give away part of your property
* the new owners also live at the property
"""
""" If a property is gifted away and the donor continues to live in the property then it is regarded as a gift with reservation and therefore added to the estate. However if market rent is paid from the day it is gifted until death or when they move out of the house then it will be regarded as a gift(PET). The 7 year clock starts from the date the rent started to be paid. """

I am sure that HMRC and government generally would benefit from people using this planning, because it is so hard to get right, and the consequences of getting it wrong are disastrous. For example, you start out paying a market rent, but forget to review it at the appropriate dates. Without realising it, you pay too little rent for a period, and then die. Here is the outcome:

• the property is still in your estate for inheritance tax purposes, so no inheritance tax is saved
• the donees have paid tax on the rent received, unnecessarily as no inheritance tax saving is achieved
• instead of a tax free uplift in base cost for capital gains tax purposes, the donees' base cost is the value at the date of the gift, so they will probably pay more capital gains tax on a sale

Even if things are done right, you have the pre-owned assets rules to negotiate, and the deprivation of assets rules if you need council support.

But the real problem is that you can't see into the future. For example:

• what if you can't afford to keep paying the rent?
• what if a donee marries someone you don't like, and then predeceases you?
• what if a donee goes bankrupt and has to sell the property?