Paying inheritance tax on your home

Your home is almost certainly your most valuable possession – and may be the main reason why your estate ends up over the threshold for paying inheritance tax. But it is one of the hardest assets to remove from the tax net – assuming you intend to go on living in it until you die.

For example, you can’t make a lifetime gift of it to your children on condition you can continue to live in it. That would count as a gift with reservation, and the home would still be treated as yours. More complex planning can trigger a charge to the pre-owned asset tax.

The problem has been removed for many married couples and civil partners by the effective doubling of the tax-free allowance through the ability to inherit each other’s unused tax allowance. There is no inheritance tax to pay if the first to die leaves their share of the home to their spouse or civil partner. When the second dies, there is no tax to pay on the home if it is worth less than £650,000 in 2010–11.

Inheritance tax on the home remains a major problem for unmarried couples and other people who live together (for example, siblings, parents and adult children, and infirm people living with carers). If you are in any of these situations and would want your cohabitee to remain in the home if you die first, if possible you should from the outset buy your home jointly rather than in the name of just one of you. This increases the chance that your tax-free allowance will fully cover the share of the home you leave. If you are the sole owner of your home, you can put it into your joint names by giving or selling a share to your cohabitee, but to avoid the gift with reservation rules or pre-owned assets tax, you must not benefit from the part of the home you transfer to them. This means taking care to pay your full share of the household bills. Provided you escape these traps, a gift of part of the home will count as a PET and so become tax-free provided you survive seven years.

Note that, if you sell a share of your home to someone you live with, they will have to pay stamp duty land tax on the price they pay. If you give them part of your home, normally there will be no stamp duty. But, if there is a mortgage on the property that they become jointly responsible for paying, this will count as if it is a price they have paid and stamp duty will be charged on the value of this commitment.

Example

Geoff, 67 and divorced, has owned his own home for many years and it’s worth around £450,000. Recently his older sister, Pat, now widowed, has moved in with him. He wants to be sure she could stay in the home if he dies before her. But, if he died in 2010–11, there would be tax on the home of 40%  (£450,000 – £325,000) = £50,000. Neither of them have much in savings or other assets, so she would have to sell the home to pay the tax. A possible solution would be for Geoff to give Pat a half share in the house. Provided he does not benefit from the half he gives away and he survives seven years, then this would remove £225,000 from his estate. His remaining share of the home would be covered by his tax-free allowance on death, so there would be no tax to pay.