There are many important decisions that parents need to take in their lifetime for their children – one of the most important being gifting them properties and assets. Gifting a property to your children can be a good idea. Still, the process may not be as simple as it may sound, and you may need to consider the impact of taxes mainly Capital Gains Tax (CGT), Stamp Duty Land Tax (or similar in Scotland and Wales) and Inheritance Tax (IHT).
Gifting Property to the children
Gifting is one of the most common ways of transferring properties to children. Gifts are usually made by parents to safeguard their children from losing out on inheritance tax (IHT) after their death and to provide an income stream for their children. Inheritance tax is generally charged at 40% and applies to all properties, including the main residence. For IHT purposes, all individuals are entitled to an allowance called the Nil Rate Band (NRB) of £325,000 (for tax year 2020-21). Furthermore, if the relevant conditions are satisfied, there is a separate allowance available for primary main residence– ‘Residence Nil Rate Band (RNRB)’ of £175,000 (for tax year 2020-21). Therefore, parents could potentially transfer £1,000,000 worth of properties to children without worrying about IHT implications.
There are certain Inheritance Tax (IHT) consequences that you must understand before gifting the property to your children -
- Gift of a property is usually a Potentially Exempt Transfer (PET). Therefore, after gifting the property, if the donor survives for 7 years – then the children don’t have to pay inheritance tax, as the property will fall outside the estate of the donor. Please note, for the gift to be a qualifying PET, it should be a Gift Without Reservation, meaning, the donor cannot benefit from the property after they have gifted it or HMRC could seek to charge IHT.
- In an event where the donor dies within 3 years of gifting the property, the PET becomes a chargeable consideration and the property will be added to the donor’ sestate and full inheritance tax at 40% will apply to the property, after deducting the NRB and RNRB, where applicable.
- If the donor’s death occurs between 3-7 years from gifting the property, the IHT payable is on a sliding scale because of the application of ‘tapered relief’. Tapered relief will be relevant in cases where the cumulative value of the gifts made in the last 7 years before the donor’s death exceeds the IHT NRB of £325,000. The tapered relief rates apply as follows -
Years between gift and death Tax Rate Less than 3 years 40% 3-4 years 32% 4-5 years 24% 5-6 years 16% 6-7 years 8% 7 years or above 0%
- Note - You cannot live in your property rent-free after gifting it to your children. If the rent is not paid at commercial rates, the gift of the property will be considered a gift with reservation and therefore not eligible for PET, and it becomes mandatory for your estate to pay inheritance tax. You need to pay rent as per the prevailing market rate in your area.
Other Tax Considerations
When gifting the property in addition to the IHT, you will also need to consider the impact of below taxes:
Capital Gains Tax (CGT)
When you gift/transfer a buy-to-let property to the children or a connected party, the gift is deemed to be a transfer at market value of the property for CGT purposes. Therefore if there any chargeable gains on the property, they will immediately crystallise and the CGT will become payable within 30 days of completion.If the property being gifted is your principal place of residence, then you may not need to pay capital gains tax,as the gains will usually be exempt under the Principal Private Residence (PRR) Relief.
The CGT payable on the transfer of a property to the child is calculated based on the market value of the property at the date of the gift less the purchase price or the total consideration paid for the property, including capital improvements and legal costs incurred on the property.
CGT is payable by the person who made the gift, also referred to as the donor. When the property is a gift where the donor has received no consideration, the donor could agree with HMRC to pay the CGT in 10 equal instalments.
The other option is - the notional gains from the property could be reinvested into the shares of a company approved for Enterprise Investment Scheme (EIS) to defer the gains, which means no CGT is payable when the funds are invested. Under EIS, you will also benefit from the income tax relief at 30% provided the funds are invested for at least 3 years. After investing in EIS for 2 years, the investment will also be eligible for the potential inheritance tax advantages available under the scheme.
Stamp Duty Land Tax (SDLT)
Stamp duty land tax is payable on the consideration received for the property and not on the equity transfer. If there is no consideration received for the property and the transfer is an absolute gift, no Stamp Duty Land Tax (or its equivalent in Scotland and Wales) is generally payable on the transaction.
Albeit, the transaction could be subject to SDLT if there is an outstanding mortgage on the property. In cases where the property in question has an outstanding mortgage, and the donor transfers the existing mortgage to the donee (the person receiving the gift) with the property, the transaction will be subject to SDLT if the value of the mortgage is over the SDLT Nil-rate threshold. The SDLT is payable within 14 days of completion.
Different ways of Gifting a Property
Once the tax implications have been assessed, the next step is to decide the method you want to choose to transfer the property to your children.
There are mainly four different ways of transferring property to children –
- Selling to the children at full market value
- Selling to the children at reduced rates (under market value)
- Transfer of property by deed of gift
- In case you are selling the property for full market value - Follow the route of standard sale and purchase.
- In case you are selling the property at under market value with some consideration – Follow the route of standard sale and purchase. Please note CGT will apply on the full market value of the property irrespective of the consideration received as children are considered connected parties for CGT purposes.
- In case transferring the property as a gift – When the transfer of property takes place between you and children only by the deed of gift (no consideration, no mortgage).
The Legal process of Gifting a Property
Sale and purchase - When the property is sold at full market value or undervalue, normal sale and purchase process needs to be followed for the transactions. The procedure is as follows:
- An independent solicitor needs to be appointed for both the buyer and seller.
- Standard protocol forms to be completed by the seller. For example – Fittings and contents forms.
- The Mortgage offer is given to the buyer (if applicable).
- Buyer orders searches
- Exchange and completion of the transaction.
The time taken for completing the whole process could be anywhere between 4 to 6 weeks and could take longer in case the property is a leasehold.
Transfer by deed of gift - When a property is transferred by a deed of gift, the following process is followed –
- Solicitor for new owners is appointed.
- The TR1 is drafted and sent to both current and new owners.
- A solicitor will verify ID1 form of current owners.
- Completion takes place
This process takes less time (usually 2 to 3 weeks) and is usually faster than the procedure followed under the standard sale and purchase.
Gifting of properties can be a complicated process, and it is recommended that you take professional advice to understand the implications before you transfer.
“This article was correct at the date of publication. It is intended for general purposes only and does not constitute legal or professional advice. Independent professional advice should be sought before proceeding with any transaction”
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