Gift With Reservation Of Benefit Guide

Sarah RyanAccount Manager @ Lawhive & Non-Practising Solicitor

Updated on 4th August 2024

If you're thinking about giving away some of your assets but want to keep some benefits from them, you need to know about a gift with reservation of benefit. This is a bit like giving someone a present but still using it yourself.

People consider gifts with reservation of benefit mainly to reduce inheritance tax on their estate. Essentially, by giving away parts of your estate during your lifetime, you can potentially lower the amount of inheritance tax.

However, there's a catch. If you give a gift but still keep some benefit from it (like living in a house you've given away), it can still be considered part of your estate for inheritance tax purposes.

This article will provide more information on how gifts with reservation of benefits work, their legal requirements, and strategies to manage or avoid potential tax liabilities.

What is a gift with reservation of benefit?

A gift with reservation of benefit is when you give something away, like a house, but you still get to use it or benefit from it somehow.

For example, if you gift your house to your child but still live in it rent-free, that's a gift with reservation of benefit.

In these circumstances, the person who gives the gift is called the transferor or donor, and the person who gets the gift is known as the beneficiary or donee.

What does the law say about gifts with reservation of benefit?

If you give something to someone (like your children) and then live for seven or more years, it is considered a full gift, and no taxes are involved. But, if you die within those seven years, the value of the gift might be taxed.

However, according to the Inheritance Tax Act 1984 and Finance Act 1986, if you give something away but keep using it, it should be treated as if you never gave it away. So, when you die, the value of that gift is still counted as part of your estate for inheritance tax purposes.

The government made these rules to prevent people from avoiding inheritance tax. Without them, people could give away their houses or money to their kids but still use them and avoid paying taxes.

What constitutes a gift with reservation of benefit?

For a gift to be considered a gift with reservation of benefit, certain conditions must be met, including:

1. You still get to enjoy or use the thing you gave away;

2. The gift was made on or after 18th March 1896;

3. The gift was not exempt from tax when it was made;

4. You continue to use or benefit from it after giving it away;

5. You don't pay the proper amount for using the item after giving it away.

So, if you give your house to your kids but still live there rent-free or without paying a fair market rent, the house may be treated as if it's still yours for tax purposes because you're still enjoying the benefits of it.

However, if you paid your children a proper, fair rent for living in the house you gave them, it might not be a gift with reservation of benefit.

Examples of a gift with reservation of benefit

Gifting property

Mr. and Mrs. Evans own a large family home in the countryside, valued at £800,000. They wish to pass the property to their son, John, to reduce their inheritance tax liability. So, they decide to transfer ownership of the house to John but continue to live in the property.

Mr. and Mrs. Evans legally transfer the title of the family home to John. The ownership is updated in the Land Registry to reflect this change. However, despite this, Mr. and Mrs. Evans continue to live in the house without paying any rent to John. They use the property just as they did before the transfer.

Because of this, the house is considered a gift with reservation of benefit.

Gifting assets

Mrs. Brown owns a valuable collection of antique furniture that has been in her family for generations. The collection is kept in her home, where she continues to live. To reduce her inheritance tax liability, Mrs. Brown decides to gift the collection to her daughter, Emily.

Mrs. Brown legally transfers ownership of the antique furniture to Emily. But, despite the transfer of ownership, Mrs. Brown continues to keep the antique furniture in her home and enjoys using and displaying it as she always has.

Since Mrs. Brown continues to benefit from the furniture by using it and keeping it in her home without paying for it, this is considered a gift with reservation of benefit, and the value of the furniture is still considered part of Mrs. Brown's estate for inheritance tax purposes.

Potentially exempt transfers and seven-year rule

If you stop benefiting from the gift within seven years before your death, the property is treated as a potentially exempt transfer (PET) at the time you stopped benefiting from it.

For example, if you give your house to your children and move out five years later if you die within seven years of moving out, the gift is treated as a PET, and inheritance tax may apply.

How does a gift with reservation of benefit affect inheritance tax?

Inheritance tax is money that has to be paid to the government when someone dies, based on the value of what they leave behind (like money, houses, or other valuables).

If you give a gift but keep benefiting from it, the current market value of the gift is treated as if it's still part of your estate when you die. This means it's included in the total value of your estate for inheritance tax.

Furthermore, taper relief won't apply to a gift with reservation of benefit unless you stop benefiting from the gift and survive for at least three more years.

When do gift with reservation of benefit rules not apply?

Sometimes, even if you keep some benefits from a gift, it doesn't count against you for inheritance tax. This includes:

De minimis benefits

De minimis benefits are small or minor benefits considered too insignificant to trigger the gift with reservation of benefit rules.

For example, you give your house to your children but occasionally stay there for a weekend. This occasional use is so minor that it doesn't count as a gift with reservation of benefit.

Deeds of Variation

A deed of variation can be used by beneficiaries to change the distribution of inheritance.

Changing an inheritance in this way doesn't count as a gift with reservation of benefit because it's done after the original owner's death and doesn't involve them retaining any benefit.

Full consideration

If you receive fair payment or something of equal value, it doesn't count as a gift with reservation of benefit because both sides get equal value.

For example, if you sell your house to your children at market value and then rent it back from them at market rent.

Joint occupation and shared expenses

If you give half your home to your child, but you both live there and share the costs of living equally, it doesn't count as a gift with reservation of benefit.

Excluded properties

Excluded properties are special types of property that aren't considered part of your estate for inheritance tax purposes, even if you still benefit from them.

Here are a few examples:

• Property outside the UK (if you are domiciled outside the UK);

• Certain trusts, like Qualifying Interest in Possession Trusts;

• Small gifts that fall under annual exemption limits;

• Regular gifts made from your surplus income that don't affect your standard of living.

What is pre-owned asset tax?

Pre-owned asset tax is an income tax charge that prevents people from avoiding inheritance tax by giving away assets but still benefiting from them.

If you give away an asset like a house but continue to live in it without paying rent, pre-owned asset tax steps in to charge you income tax based on the benefit you receive. The tax is calculated using the market rent that you would pay if you were renting the property at an open market rate and applies if the annual benefit exceeds £5,000.

How do you avoid gifts with reservation of benefit rules by paying rent?

If you gift a property but continue to live there, you can avoid it being a gift with reservation of benefit by paying rent at an amount that reflects what you would pay if you were renting from a stranger.

For example, if the market rent for a similar property in the area is £2,000pcm, you should pay this amount to the new owner.

It is essential to have a formal rental agreement in place that specifies the rent amount, payment schedule, and other relevant terms.

The person receiving the rent will also need to declare this rental income and may have to pay income tax on it.

Does gifts with reservation of benefit apply to properties abroad?

If you are domiciled in the UK and you gift a foreign property to someone else but continue to use it, it is considered a gift with reservation of benefit.

For example, if you give your villa in France to your children but continue to stay there every summer without paying for it, the villa's value will be included in your estate for inheritance tax purposes when you die.

Are gifts to discretionary trusts subject to gift with reservation of benefit rules?

If you set up a discretionary trust and are a potential beneficiary, rules typically apply because you can still benefit from the trust, even if you are not actively receiving benefits at the moment.

This means the value of the trust's assets would be included in the settlor's estate for inheritance tax purposes.

To avoid gifts with reservation rules, you should not be included as a beneficiary of the trust.

How to set up a gift with reservation of benefit

Seek professional advice

Given the complexity of inheritance tax and gift with reservation of benefit rules, it's essential to seek advice from an estate planning lawyer who can help you understand the implications and structuring of the gift.

Establish terms of use

Clearly define the terms of how you will continue to use or benefit from the property. This includes any conditions like paying market rent or specific usage rights.

For example, if you will continue living in a house you are gifting to your child, you should establish a formal rental agreement to pay market rent to them.

Draft the legal documents

Work with your lawyer to draft the necessary legal documents, such as a deed of gift, outlining the terms and conditions of the arrangement.

For example, if you're gifting a house to your children but still want to live there, a formal deed of gift should be created to transfer ownership while specifying the conditions of your continued residence.

Transfer of ownership

Once all of the above arrangements are made and the legal documents are in place, officially transfer ownership to the recipient.

How do I avoid a gift with reservation in benefit?

If you want to give away something valuable, like a house, but don't want it to be counted as part of your estate for inheritance tax, you need to make sure you don't keep using or benefiting from it.

You can do this by:

• Paying market rent if you give your house to someone else but want to keep living there;

• Moving out completely after giving away a property;

• Set up a trust where you are not a beneficiary.

Before considering giving a gift, it's always wise to get advice from legal and financial professionals to make sure you're following the rules and making the best decisions for your situation.

Is a discounted gift trust a gift with reservation of benefit?

A discounted gift trust is not considered a gift with reservation of benefit as the right to receive regular payments is accounted for and valued upfront.

This retained right is considered when calculating the inheritance tax, which means it's not hidden or ignored as it might be in a gift with reservation of benefit scenario.

Get expert help with gifts with reservation of benefit

At Lawhive, our network of money, tax, and debt lawyers is on hand to provide tailored advice to make sure your gifts are structured correctly, helping you minimise tax liabilities while complying with legal requirements.

Whether you need assistance with setting up trusts, understanding tax implications, or drafting legal documents, we're here to guide you.

Contact us today for a free case evaluation and quote for the services of a specialist lawyer.