Inheritance Tax Avoidance – Pre-Owned Assets

Navigating the complexities of Inheritance Tax (IHT) and Pre-Owned Assets rules is essential for effective financial planning. At AH Accountants, we specialize in providing taxation advice tailored to individuals in the Sheffield area, helping you avoid unintended consequences from this intricate anti-avoidance legislation.

What Are Pre-Owned Assets Rules?

The Pre-Owned Assets rules come into play when an individual successfully removes an asset—typically property—from their estate for IHT purposes but continues to derive benefits from that asset. These rules can be challenging to understand, so professional guidance is crucial.

A Brief History of Inheritance Tax

IHT was established nearly 40 years ago, imposing tax on certain lifetime gifts and estates upon death. This framework introduced Potentially Exempt Transfers (PETs), which allow individuals to gift capital without incurring IHT charges if they survive for seven years post-gift. While this offers opportunities for significant wealth transfer without tax implications, various tax and non-tax factors must be carefully evaluated.

The Reality of Gifting

Many individuals find themselves unable to make substantial lifetime gifts due to their capital being tied up in assets like family homes or businesses, or because it generates necessary income.

Gifting the Family Home: Pros and Cons

Can you gift your family home to your adult children while continuing to live there? Technically, yes, but this approach has significant drawbacks:

• Security of Tenure Risks: Your right to live in the property may be compromised.
• Loss of Capital Gains Tax Exemption: This could lead to tax liabilities when you eventually sell the property.
• IHT Complications: Such a gift doesn’t effectively remove the property from your estate due to the Gift with Reservation (GWR) rules, which state that the property remains part of your estate if you continue to benefit from it.

Understanding Gift with Reservation Rules

GWR rules deem that properties gifted while you retain use will still count as part of your estate for IHT purposes. This complexity necessitates expert advice if you’re considering such transactions.

Strategies to Navigate the Rules

To circumvent GWR issues, various complex schemes emerged, such as the home loan or double trust schemes, allowing individuals to retain use of their homes while minimizing IHT exposure. For instance, if a family home is valued at £750,000, the potential IHT savings could be substantial.

HMRC’s Stance on Gifting Schemes

Over time, these schemes faced legal scrutiny and were largely curtailed. In response, HMRC introduced an income tax charge on individuals who continue to enjoy the use of a gifted asset, referred to as the Pre-Owned Assets (POA) rules. These rules primarily target land and buildings but also cover certain chattels and intangible assets held in trusts.

How POA Rules Work

The POA rules apply when an individual successfully removes an asset from their IHT estate yet continues to benefit from it. Here are a couple of illustrative examples:

Example 1: Ed gifted his home to his son Oliver in 2014 but continued living there. This transaction remains under GWR rules, meaning the property is still part of Ed’s IHT estate.

Example 2: Hugh gifted cash to his daughter Caroline in 2015, and she later bought a property that Hugh moved into in 2020. The POA rules would apply here, as Hugh is benefiting from the asset even though it was acquired through his daughter’s gift.

Exclusions from POA Rules

Certain transactions, such as property transfers to a spouse or former spouse under a court order, are exempt from these rules.

Understanding the Charge

The POA charge is based on notional market rent, which can lead to significant tax implications. For example, a property valued at £1 million might incur an annual income tax charge of £20,000 for a higher-rate taxpayer.

Properties must be valued every five years, and actual rent paid by the occupier can reduce the charge. However, if the deemed income from the property is below £5,000, the charge does not apply.

Strategies to Avoid the Charge

Here are some strategies to consider if you’re facing the POA charge:

• Dismantle Existing Schemes: This may not always be feasible, and the costs can be prohibitive.
• Pay Full Market Rent: This can eliminate the charge but may not be a desirable option.
• Elect for IHT Treatment: You can choose to treat the property as part of the IHT estate instead of facing the annual income tax charge.

Making the Election

The election allows you to avoid the annual income tax charge, but the asset will be treated as part of the IHT estate, potentially incurring a future tax liability. Deciding whether to make this election should depend on your personal circumstances.

Reasons to Elect

• The asset qualifies for business or agricultural property reliefs for IHT.
• The asset’s value remains within the IHT nil rate band.
• The owner is relatively young and healthy.

Reasons Not to Elect

• The donor has a short life expectancy, making the short-term income tax charge negligible compared to future IHT.
• The POA charge is below the £5,000 threshold.
• The donor prefers not to transfer IHT burdens to the beneficiary.

Elections must be made by January 31 in the year following the charge’s first application, though HMRC may permit late elections at their discretion.

Planning Ahead

While the POA rules complicate tax planning, they do not entirely eliminate opportunities. The Residence Nil Rate Band, introduced on April 6, 2017, reduces the necessity for such planning for homes valued under £350,000 (£175,000 for singles) if left to direct descendants. Estates exceeding £2 million may experience a gradual tapering of this relief.

Sharing Arrangements

Gifting a share of your family home to a living family member can help avoid both GWR and POA charges. However, this approach is suitable only for long-term arrangements.

Equity Release Options

Equity release schemes, where you sell part or all of your home, are not affected by POA rules. However, cash received will be part of your IHT estate.

Importance of Wills

Ensure your Will is tax-efficient, as it is not subject to the POA regime.

Conclusion

This area is complex, and seeking professional advice before taking action is essential. The POA rules can impact transactions dating back to March 1986, underscoring the importance of careful planning.

How AH Accountants Can Assist You

If you reside in the Sheffield area and have questions about Inheritance Tax avoidance, Pre-Owned Assets, or need guidance on IHT planning, please contact us at AH Accountants. We’re here to help you navigate these intricate regulations effectively.