Mistakes over estate planning come to light when, as a result of COVID-19, families can be hit with large and unexpected bills for inheritance tax. Some gifts can "go wrong". One particular rule that needs to be understood is Gift with Reservation of Benefit, or GROB. The author of this article examines the field.
Oliver Embley, senior associate, Wedlake Bell, examines how inheritance conversations can take a tough turn when families are hit with large and unplanned-for tax bills, perhaps brought on by the pandemic. The COVID-19 crisis has been a grim reckoning for some families and has required advisors to be on top of their game concerning the steps people should take as early as possible. Thanks, therefore, to the author for this insightful commentary. The usual editorial disclaimers apply. Join the conversation - email firstname.lastname@example.org and email@example.com
Following the COVID-19 lockdown, families may be landed with large and unexpected inheritance tax bills as a result of “gifts gone wrong”. Claims have even been made that, in the last three years, such mistaken planning has raised more than £300 million ($391.5 million) for HM Revenue and Customs. Such situations have arisen in recent months where parents have previously gifted property to their adult children, moved out, but moved back in during lockdown to shield from the virus with their children.
With rising house prices and older generations being “over-housed”, it has been common for parents to gift what was the family home to adult children and downsize. From an IHT perspective, as soon as the parents move out of the gifted property, the IHT “seven-year clock” starts. As such, after seven years, the value of the gifted property will fall out of the parents' estates for IHT, saving 40 per cent tax and keeping the family home out of the taxman's reach.
However, the Gift with Reservation of Benefit rules will catch arrangements where there has not been a full gift because parents have kept back some benefit for themselves. Where there has been a GROB, the value of the gifted property will remain in the parents' estates for IHT.
A classic example of a GROB is where parents make a gift of the family home to their children but continue to live there without paying a full market rent. This is well known. However, clients often assume that because of the “seven-year rule”, there will be no problems if they move back in after seven years has expired. Unfortunately this is not correct and a GROB can be reignited at any time, including as a consequence of a lockdown and the desire to shelter with family members.
Thankfully there are some exceptions to the GROB rules which might save families from this costly tax trap.
Perhaps the simplest solution to avoid a GROB is for parents to pay their children a full market rent if they move back into a property they have gifted. Whilst this should avoid a large IHT bill, from an income tax perspective the arrangement is not particularly efficient; the parents will often be paying rent from already taxed income and the rent will also need to be reported to HMRC and tax paid by the children.
Parents could make lump sum annual rental payments to their children from capital if they can afford to do so. Although the children will still be liable for income tax, this will have the effect of taking further capital out of the parents' estates immediately for IHT purposes.
It is important for a surveyor to assess the market rental value of property regularly. Ideally, a formal rental valuation should be carried out by a surveyor and if the parent lives with the child for an extended period, the valuation should be updated every year or two.
It is likely that HMRC will investigate such arrangements following a parent's death. HMRC will normally ask for copies of the surveyors' rental valuations and bank statements evidencing payment of rent.
Illness and care
If a parent has fallen ill, it may be necessary for them to move back in with a child to be cared for because there is no other option, especially as care homes have been locked down since March. Fortunately the law recognises a situation like this and provides that there will be no GROB where:
1. there is an unforeseen change in the donor's personal circumstances;
2. the donor is no longer able to maintain himself through old age or infirmity; and
3. the occupation represents reasonable provision for the donee for their care and maintenance.
HMRC cites an example of a “perfectly healthy donor”, Stephen, who gifts his house to his son, Peter. Five years after the gift, Stephen becomes ill with motor neurone disease and he has to move back in with Peter to be looked after. In these circumstances, HMRC would accept that there is no GROB; however the circumstances where this exception applies are narrow and have yet to be tested in circumstances bought about by COVID-19.
Importantly, the exception will only apply where the donor and the donee are related. Furthermore, it is likely that HMRC will ask for evidence that, at the time of the gift, the parent was healthy and their health subsequently deteriorated. Medical records will therefore be the key piece of evidence if this exception is to be accepted by HMRC following a parent's death.