Is it better to gift property or leave it as an inheritance?

We often get asked whether it is better, in tax terms, to gift a property to someone or to leave it to them as an inheritance.

There are considerable differences between giving a property away during your lifetime or passing it on when you die. As ever with tax considerations, the answer isn’t entirely straight forward, and depends very much on what you want to gift, to whom and when.

Jo Summers, Partner in our Private Wealth & Tax team discusses the various scenarios and the associated tax considerations to think about, to provide more clarity on the pros and cons of each option.

Lifetime gift

If you make a lifetime gift of a property, there are various taxes to consider. Sometimes it’s a surprise to hear that more than one tax can apply.

If you are making the gift to another individual, there is no immediate charge to inheritance tax (which is badly named, as it can apply to lifetime gifts as well as inheritances).

Instead, the tax authorities wait to see if you survive the gift by seven years. If you do, there is no inheritance tax on the gift. If you survive by at least three years, the inheritance tax bill is reduced by 20% each year.

On the other hand, if you make the gift to a trust or a company (that you don’t own), then there can be an immediate charge to inheritance tax on that gift.

The gift is also a disposal for capital gains tax purposes, which means that you may have tax to pay if the value of the property has gone up since you acquired it.

This can be a particularly unpleasant surprise; it’s normal to pay capital gains tax when you sell a property, as you then have the sale proceeds to pay the tax.

However, in this situation, you’ve made a gift to someone who hasn’t given you anything back in return, but you still have the same gains tax bill on any profit. If the property is your main home, it may be exempt from gains tax, but you do need to take advice.

Another consideration is that there can be a charge to stamp duty (SDLT) if you give away a property that has a mortgage on it.

This is because the recipient is treated as taking over the burden of paying the mortgage, which is ‘consideration’ for SDLT. The charge is based on the value of the outstanding mortgage.

You’re also likely to need the mortgage company’s consent before you give the property away, as they’ll want to be sure whoever you give it to can afford the mortgage payments.

Finally, if you’re giving a property away you need to make sure you don’t reserve any benefit from that property.

For instance, if the property is rented out, the rental income must go to whoever you gave the property to. You also can’t live in the property rent-free after you’ve made the gift.

If you don’t give away the property completely, it’s likely to be classed as a ‘gift with reservation of benefit’. This is the worst of all worlds, as you have the tax issues listed above, but the property will be treated as if it’s still part of your estate when you die, so full death inheritance tax may be payable.

Passing property on when you die

Here, the main consideration is inheritance tax. Depending on the value of what you own, all your assets may be subject to inheritance tax at the rate of 40%.

There is a spouse exemption, so you can usually pass assets to your spouse or registered partner tax-free, but unmarried couples don’t qualify for this relief. There are also exemptions for giving money/assets to charity.

There is then a threshold, so you can pass on £325,000 without any inheritance tax being due, and if you are a widow/widower, this may be £650,000 depending on whether you inherited everything from your late spouse. This threshold will be reduced if you’ve made large gifts during the last seven years before you died.

There is also a separate inheritance tax relief worth up to £175,000 if you are passing on a property that is (or has ever been) your residence to direct descendants (children, grandchildren etc). Again, depending on whether you are a widow/widower, you might have an additional £350,000 relief.

Fortunately, you don’t need to worry about capital gains tax. There is a special rule that re-values all your assets to the date of death but doesn’t charge any tax on that gain.

Instead, whoever inherits your assets effectively gets a tax-free uplift in value. For example, if you bought a property for £500,000 and sold it for £750,000 during your lifetime, that gain is taxable (unless the property was your principal residence).

However, if you gave the property away in your Will, your heirs receive a £750,000 property without anyone having to pay tax on the gain.

You need to think about mortgages on any property you own, as your heirs may not want to inherit a property that is mortgaged.

And you might find the mortgage company insists you have life insurance to pay off the mortgage when you die.

It’s important you make sure these insurance funds don’t get paid into your estate, as that will increase the value of your estate and may mean more inheritance tax is payable.

It is better to ensure the insurance funds are paid to someone else, such as the person you’re planning on giving the property to. Most insurance companies will have standard forms helping you do this.

Which is best?

There is no right or wrong answer. Everything will depend on your particular circumstances, what you want to give away, to whom and when.

If the property is your main home, don’t try to give it away during your lifetime: if you continue to live in the property without paying a full commercial rent this will be a ‘reservation of benefit’ and you won’t save any inheritance tax.

You’d be better off keeping the property until you die, so it passes with the uplift in value to your heirs, and makes use of the additional relief if you’re passing the property to your children or grandchildren.

On the other hand, if you have a property that you don’t live in, you might consider giving this away during your lifetime, in the hope of surviving the gift by seven years, so no inheritance tax is due at all.

You just have to be aware of the potential capital gains tax and it’s far easier if there’s no mortgage on the property. You also need to be sure you can live without the rental income, as that will go to the new owner of the property.

To ensure you choose the best option to meet your objectives, seek professional advice from a qualified lawyer – preferably one who is a member of STEP – the Society of Trust and Estate Practitioners.

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