A number of taxpayers took advantage of last year’s extension to the Stamp Duty Land Tax (SDLT) nil rate band for property in England and Northern Ireland to purchase property for their children, or gift property already owned. Now the temporary reduction has expired, gifting property can be more expensive in tax terms.
In this article we look at the considerations when gifting property to children. It is a complex area and the tax treatment of any transaction must always be considered ‘in the round’ rather than focussing on individual taxes. As always, we recommend that specialist tax and legal advice is sought regarding individual circumstances before taking any action.
The age of the child receiving the gift is important. Children under the age of 18 years are not legally able to own real estate in their own name and so property is usually held under either a ‘bare trust’, with an adult acting on their behalf, or under a more formal trust structure (this may be age 16 in Scotland, subject to the facts of the case). A formal trust is a legal entity in its own right and the donor can be a trustee and retain an element of discretion over the assets. Under a bare trust, the asset and any income net of tax is legally the child’s asset and once aged 18 they are able to deal with it as they wish, without the restriction of parental consent.
Capital gains tax
A gift of property is subject to capital gains tax (CGT), which is charged on any profit arising, or treated as arising, on the gift.
Where a gift is made to a close family member, the market value of the asset is substituted for any sums which are actually paid and CGT is charged on the gain deemed to arise. The gain subject to CGT is calculated as the increase in value arising between the date of acquisition and the date of disposal, less the purchase price, any capital improvement costs and any associated costs of purchase or gift, eg SDLT, legal fees and estate agent’s fees.
The first £12,300 of gain is tax-free under the CGT annual exemption (provided it has not already been used) and the balance is charged at 18% or 28%, depending on the donor’s income for that tax year.
If the property is bought and is gifted immediately to the children there should be no gain to tax, provided there is no increase in value between the dates of purchase and gift.
Where the property gifted was the donor’s main home, Principal Private Residence relief (PPR) may exempt some or all of the gains from CGT. And if the recipient lives in the property as their main residence, they may also qualify for PPR when they come to sell the property.
Where there is tax to pay, the gift of the property must be reported to HM Revenue & Customs (HMRC) within 30 days, with tax also payable by the same deadline.
Inheritance tax (IHT) is generally charged on an individual’s estate at 40% of the estate value exceeding £325,000 (or £500,000 where a main residential property is passed on death to a lineal descendant and the total value of the estate is less than £2 million). Therefore, it can be good planning to gift unneeded assets during an individual’s lifetime to reduce the value of the remaining estate. There are, however, a few traps to be aware of regarding lifetime gifts.
Gifts, including property, made to individuals during a person’s lifetime are only exempt from IHT if the donor survives seven years from the date of the gift. Where the donor survives at least three years, but less than the full seven years, a tapered IHT rate applies.
However, if the donor retains an interest in the property, it is treated as a ‘gift with reservation of benefit’ and the property remains in their estate and is taxed in full on death. Therefore, if a donor wants to gift their family home to children and continue to live in it, they would have to pay the children the full market rate rent to successfully remove the property from their estate. The recipient/s may also be subject to income tax on the rent received.
Gifts made to trusts are subject to an immediate IHT charge of 20% where the value of the gift exceeds the available nil rate band of £325,000. However, the nil rate band is refreshed every seven years, and this means that significant gifts can be made free from IHT during an individual’s lifetime.
Gifting rental property that produces an income to children can be a good way to utilise their income tax annual allowance and their lower tax rate bands. However, where parents gift assets to children aged under 18 years old, any net income exceeding £100 per annum is taxed on the parents as if they still owned the asset. This rule does not apply to income generated from gifts from grandparents.
Gifting away an income stream can have other implications for the donor, as they will be reducing their own income. For example, this may affect pension contributions limits or their own mortgage conditions.
Stamp Duty Land Tax
SDLT is a tax that applies on the transfer of interests in land and property located in England and Northern Ireland. SDLT is charged on the consideration paid for the transfer, or where the land or property is subject to debt, the value of the debt transferred with the gift. This means that property purchased to gift to children could potentially be charged to SDLT twice, firstly when the parent purchases the property and then again on the later gift to their child if there is debt secured on the property transferred. The SDLT nil rate band for residential properties is £125,000 from 1 October 2021, after which SDLT is charged at increasing percentages depending on the value charged.
There are equivalent tax charges for land located in Scotland where the Land and Buildings Transaction Tax threshold is £145,000 for residential property, and in Wales where the Welsh Land Transaction Tax threshold is £180,000 for residential property.
If the gift is made to adult children, the property is immediately outside the donor’s control and therefore, if gifting part or all of the family house, it is precautionary to consider the longer-term effects of divorce or bankruptcy within the family, which can result in the loss of the property.
With regard to care home fees, if the donor gifts assets or income, including property, so that these won’t be included in the financial assessment for care home fees, local authorities may still include the value of these assets regardless of the fact they are no longer owned.
Depending on the reasons behind gifting a property, it may be better to gift the post-tax rental income instead. That way the donor still retains ownership and control of the asset and it can be an opportunity involve an adult child in the running of the rental property.
Alternatively, a proportion of the property could be gifted to an adult child, which, whilst still subject to the tax issues above, could provide an income stream equal to their percentage ownership of the asset.