What is a gift with reservation?
A gift with reservation occurs when an individual makes a gift of an asset during their lifetime but continues to benefit from it. The most common example of a gift with reservation arises when someone gives their property away but continues to live in it.
Spurred by the concern about the property being used to fund long term care it is often suggested that the family home is transferred into the names of the children. It should be pointed out that this is not always a good idea as what happens to the property now depends on the children’s circumstances. If they get into financial difficulties or the get divorced the family home becomes vulnerable to creditors and perhaps a claim from the divorcing spouse.
It is sometimes suggested a property should be put into a trust to avoid potential issues associated with gifting property to family members. In brief, a trust is a legal arrangement where an asset, such as a property, is given to someone else to look after for the benefit of a third person. So, for example, a property could be put in trust and the trustees would then look after it for the benefit of the children. Although this approach may solve some issues it does not avoid a property being regarded as a gift with reservation.
Does the 7-year rule apply? Most individuals will also be aware that an individual can give gifts during their lifetime which are potentially exempt from Inheritance Tax. To continue with the example of a property, if desired the donor could give their property away and if they survived 7 years from the date of transfer then the property would not form part of their estate.
This apparently solves 2 problems. It prevents the property from being used to fund care and on the face of it avoids it being taken into account for inheritance tax calculations.
However, this is not the case. It should be noted that the 7-year rule no longer applies if after giving the property away the donor continues to live in it without paying a proper market rent which is regularly reviewed. In fact, the property is a gift with reservation. It is treated as still being owned by the donor and remains part of their estate for inheritance tax (IHT) purposes. Furthermore, the gift is also likely to be regarded as ‘deliberate deprivation of assets’ and its value could still be assessable in working out any contribution to care costs.