Inheritance Tax (IHT): Understand gift with reservation of benefit rules

To pass on your estate and assets tax efficiently and save a hefty inheritance tax bill, careful planning throughout your lifetime is crucial. One of the ways to reduce inheritance tax is to make lifetime gifts.

A gift with reservation of benefit is where an individual gifts a property to someone else but retains a right of benefit over the gifted property. Gifting assets for inheritance tax purposes can save IHT, but careful consideration is required, and specific rules apply.

In this blog, we’ll explain all the rules around gifted property and how gift with reservation of benefit rules apply.

Why do I need to undertake inheritance tax planning?

If your estate is of a value that inheritance tax will need to be paid upon your death, then seeking tailored advice on reducing your inheritance tax liability is crucial.

How much inheritance tax your beneficiaries pay will be dependent on the planning you do during your lifetime.

A common IHT reduction strategy involves gifting assets during your lifetime to reduce the value of the estate upon death. However, gifting assets can be complicated, especially where gifts with reservation of benefit (GWROB) rules apply.

Lifetime gifts are assets, like money or property, that an individual gives away during their lifetime to reduce future inheritance tax liabilities. They can also be known as potentially exempt transfers (PETs) for IHT purposes.

What are the gifts with reservation of benefit rules?

One way to reduce IHT liability is by gifting assets to your loved ones, this could include making lifetime gifts. This usually involves gifting away personally owned assets, either directly or indirectly, to their heirs.

Gifting assets can occasionally be affected by the gift with reservation of benefit rules and if caught by these rules, it may counteract any IHT benefit that you sought.

These rules apply when giving an asset away, but the donor continues to derive a benefit from that asset until the donor’s death. One prominent example of this is a parent gifting their property to their child, but the donor continues to live in this property rent-free.

In such arrangements, the gift of the asset is said to be a gift with reservation of benefit by the donor.

What is the IHT impact of GWROB when gifting assets?

For a gift to be considered a potentially exempt transfer (PET) for IHT purposes, it must be a complete transfer of ownership and the donor must give up all control or benefit over the asset.

A Potentially Exempt Transfer (PET) that may be subject to IHT if the donor dies within 7 years of the gift being given (a ‘failed’ PET).

If the donor continues to utilise the asset after gifting, there will be a reservation of benefit. In this case, the gift will not be considered a PET and could still be subject to inheritance tax.

There are instances where a ‘double charge’ to IHT occurs if the donor dies within 7 years of the gift with reservation of benefit. If this is the case, then HMRC can choose to charge IHT on the asset in the death estate, or the failed PET, whichever option collects the most tax.

For IHT calculations, it is best to treat an asset with a gift with reservation of benefit as still forming part of the donor’s estate at the date of death and assume IHT will be charged on the value of the asset.

How can I avoid gift with reservation of benefit rules?

There can be ways to avoid gift with reservation of benefit rules, but you should seek professional advice to ensure you minimise tax liabilities.

The gift with reservation of benefit rules would not apply in the following circumstances:

The donor pays a full market rent for the gifted property

If the donor continues to use an asset after they have gifted it, but they pay rent at full market value for the continued use of the asset, the gift with reservation of benefit provisions may not apply.

To avoid the GWROB rules, you will need legal documents such as a formal rental agreement or tenancy agreement. You will also need to receive regular rental payments and review the rent you are charging on the house to ensure the tenant is paying market value rent at all times.

For tax planning purposes, you will need to consider the fact that the donee will be receiving potentially taxable rental income. Therefore, you’ll need to consider the income tax implications of the donee receiving rent, the cost of the donor paying rent versus the potential IHT bill in future.

Even if the gift with reservation of benefit rules don’t apply and the donor pays rent, the gift will be considered a full transfer of ownership and the seven-year rule for inheritance tax may apply. The seven-year rule states that if a gift is given and it is within a seven-year period of death and the total value of the estate is over £325,000, then the person who receives the gift may have to pay inheritance tax.

The donor is ‘virtually excluded’ from benefiting from the asset

Another example where the gifts with reservation of benefit provisions may not apply is if the donor is ’virtually excluded’ from benefiting from the gifted asset.

The definition of ‘virtually excluded’ is not clearly defined; however, HMRC treat it as any benefit obtained by the donor that is insignificant in relation to the gifted asset.

One example of this could be that the donor makes social visits to the gifted property or makes temporary stays in the property; this could be for family or medical reasons, for example.

Selling pre-owned assets

Some individuals try to avoid the gift with reservation of benefit rules by selling the property, giving cash to the donee who then buys a new property where the donor will live in the future. Even if the money is not traceable, an income tax charge would arise under the Pre-Owned Assets rules. These rules provide for a charge to income tax on benefits received by a former owner of property. It applies to individuals who continue to receive benefits from certain types of assets that they once owned.

Terminating the benefit received

Where gift with reservation of benefit rules have been triggered, if the donor decides to stop receiving the benefit, this won’t mean that the asset reverts to being immediately outside of their estate. In this instance, the asset will be treated as another gift from the donor to the donee from the date that the benefit is no longer being received. Potentially exempt transfer rules and charges may still apply and the potential for double taxation as mentioned above may also apply. Seek professional advice.

How can dns accountants help?

To minimise your inheritance tax liability, ensure you have the necessary legal documents when gifting assets, advise on your estate for inheritance tax, contact dns accountants.

We can help you with all your IHT planning needs. Contact dns today on 0333 0600 706 or email us at [email protected].

About the author

Siddharth Agarwal
I am a Chartered Tax Advisor (OMB) and ACCA. I have 9+ years of experience in owner-managed business taxation issues, company reorganisations, property taxation, and succession planning. I also work with private clients on bespoke tax planning strategies for trusts, residence status, and non-residents. I aim to fulfil my professional duties towards my clients and keep them satisfied, my utmost priority. I believe in establishing and maintaining businesses and personal relationships as the key to mutual growth.