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 tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.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.

Market rent
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.

The de minimis exception
The GROB rules provide that if an asset is gifted it must be enjoyed “to the entire exclusion or virtually to the entire exclusion” of the donor. The word “virtually” gives some scope for a parent who has gifted a property to a child to move back in for short periods and in limited circumstances without there being a GROB.

HMRC gives various examples of where they will not consider there to be a GROB in these circumstances. The prescient examples are where a parent moves back into a house they have previously given away because they are convalescing after medical treatment or even if the parent is looking after a child who is convalescing after medical treatment. As such, if there is not sufficient evidence to support a claim for the “infirm relative” exception it may be possible to claim the de minimis exception to avoid a GROB. 

HMRC also concedes that there will not be a GROB where a parent stays in a previously gifted property without their child for not more than two weeks each year or if the parent stays with their child for no more than one month each year. Therefore, even if there is no illness in the family it may be possible to claim that the de minimis exemption applies for short periods of occupation by a parent of up to one month.

If all else fails….
If none of the exceptions apply and a GROB has been reignited it is not necessarily a disaster. The IHT seven-year clock will start running again as soon as the parent moves back out. There is, of course, a risk of an IHT charge in that seven-year period but depending on the parent's age and health it is often possible to take out life insurance to cover that IHT risk. The policy would only need to be in place for seven years so it may be cost effective. If the parent dies within the seven years and IHT becomes payable, it would be covered in full by the insurance.

It is important to bear in mind that if it looks as though there has been a GROB of the family home and one of the exceptions is claimed, the onus will be in the executors of a deceased parent to provide evidence to HMRC to support the claim. If such evidence cannot be provided, families may sadly find themselves with large and unexpected tax bills.