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May 7, 2014updated 11 Jan 2016 1:02pm

How can I avoid paying inheritance tax on my home?

By Spear's

Headlines about UK house price inflation abound. The English Land Registry has reported a 5.6 per cent average annual house price increase for England and Wales since March 2013; in London it’s 12.4 per cent. These figures are conservative compared to data released by some UK building societies recently.

This is good news for homeowners, but increasing property prices mean a bigger UK inheritance tax (IHT) take for the UK Government and, as many families who fail to plan find out to their cost, IHT is a very real family wealth diminisher.

IHT is a problem not just for UK domiciliaries either. Non-doms pay IHT on directly held UK property. And when you consider that individuals pay IHT at a flat rate of 40 per cent on death on, broadly, value above £325,000, the IHT tax take on UK property can be substantial. Sometimes the home has to be sold to pay the IHT bill.

Read more on inheritance tax from Spear’s

The truth of the matter is that it is very difficult for homeowners to completely mitigate IHT on the property they live in as their home. The IHT legislation contains anti avoidance measures preventing individuals making gifts that are successful for IHT purposes of property which they subsequently occupy or otherwise benefit from.

Continuing to occupy a property which you have given away to, say, a child, without paying that child a full market rent, does not remove the property from your estate for IHT purposes, even if the property is transferred into the child’s name. These measures (known as the ‘gifts with reservation of benefit’ [GROB] rules) are extremely unforgiving.

What can be done? More importantly, given fierce disapproval (by HMRC and the public) of aggressive tax planning schemes, what can be done safely and within the spirit of the law?

For non-dom couples who directly own UK property, all that may be required is to ensure that UK property passes to the surviving spouse after the first spouse dies, thereby bringing into play the IHT spouse exemption. A UK will may do the trick, although foreign succession rules and matrimonial property regimes may complicate matters.

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If, after the first death, the surviving spouse is likely to sell up and leave the UK, there will be no UK home owned by the time of the surviving spouse’s death to tax to IHT. Here, a tax deferred is indeed a tax saved.

For couples, wherever domiciled, who do plan to own a UK home at the time of the surviving spouse’s death, this will not work. Other than insurance, what else can be done?

Again, for married couples, making wills could help. One example of this is writing a will to safely engineer a split in the equity ownership of the home between the surviving spouse and, say, a trust in the will of the first spouse to die. This should reduce the IHT payable on the home, on the surviving spouse’s death, by approximately £60,000 per £1,000,000 of equity. This technique is successful because it relies on the way that shares in property are valued for IHT purposes. There is nothing controversial in that.

The attraction of will-based planning is that it does not involve giving away any part of the property in your lifetime. However, to make significant inroads into the IHT bill on the home, families need to plan together.

Parents who are prepared in their lifetimes to give equity to their children and who can occupy their home with the children (not necessarily 24/7 and which could mean separate properties in the same complex) could take advantage of a let-out from the GROB rules in the IHT legislation. Only happy families need apply.

Helena Luckhurst, Partner, Fladgate LLP

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