An inheritance sometimes creates tax or state benefit issues for the person receiving it. What are these potential issues and can anything be done about them?

I’d like to gift (tax efficiently) my inheritance to my children

Dad who inherits assets may not want these because it either creates or increases his own inheritance tax bill on his death. It may, therefore, be more beneficial to pass these assets down to the next generation now (who may hugely benefit from an early inheritance to help them, say, get on the property ladder) whilst reducing the value of Dad’s estate for inheritance tax purposes.

If Dad gifts these assets to his children now then he would need to survive for 7 years for the value of those assets to be outside of his estate for the purposes of inheritance tax. If, however, he gifted these by a compliant Deed of Variation then there would be no 7-year rule and therefore no inheritance tax issue in relation to his gifts.

So what is a Deed of Variation and why does it work?

A Deed of Variation is a legal document that consists of two elements.

Firstly it acts as a Deed of Gift setting out exactly what is to be gifted and to whom. Secondly, it acts as a ‘tax fiction’, in that if it is drafted in the right way and signed within the time limits then HMRC will regard anything gifted as coming from the person who has died and not from the person actually doing the gifting. This is why the 7-year rule mentioned above is circumvented.

Does a Deed of Variation avoid inheritance tax in other ways?

A Deed of Variation can be used to take inheritance out of a person’s estate if that person dies soon after coming into the inheritance. For example, Mum passes away leaving her estate equally to sons Jason and Chris but sadly Chris dies very shortly afterwards leaving his estate to his two children.

At this point, half of Mum’s estate now belongs to Chris’ estate and this has increased the inheritance tax bill by 40% on everything inherited by Chris’ estate. Chris’ children use a Deed of Variation to redirect the half share of their grandmother’s estate from Chris’ estate directly to them, so decreasing the value of their father’s estate and therefore decreasing the amount of inheritance tax that they will have to bear.

So if we said that the share of their grandmother’s estate which now belongs to Chris’ estate is valued at £500,000 and is fully charged to inheritance tax at 40%, the tax bill on this is £200,000. However, Chris’ children have used a Deed of Variation to redirect this £500,000 inheritance from their father’s estate directly to themselves hence saving the £200,000 tax bill.

Are there any potential Stamp Duty benefits?

There may be some Stamp Duty saving; let’s say Mum passed away leaving her home subject to an equity release to her son who now wishes to raise finance on the Property but in order to raise the finance the Property must be put into both his and his wife’s names.

There is a potential Stamp Duty charge which could be exasperated by having to pay the higher rate if they already own other property. This is because HMRC will regard the wife’s payment of half the existing equity release debt as being a chargeable consideration. This repayment of the equity release could be regarded here as a ‘purchase price’ and if this exceeds the Stamp Duty Land Tax threshold then tax will be payable.

A Deed of Variation gifting the Property equally to the son and daughter-in-law would mean that HMRC would regard the daughter-in-law as having acquired the property (subject to the equity release) from her late mother-in-law’s estate.

As HMRC regards the daughter-in-law as already being entitled to the Property at the time it is remortgaged, then there is no purchase of the property and therefore no chargeable consideration and no Stamp Duty Land Tax to pay.

Are there any potential benefits from a Capital Gains Tax perspective?

Mum passes away leaving her home subject to an equity release to her son, as above, but this time the son pays off the equity release from his own cash assets and has decided to rent the Property out.

After 1 year he decides to sell the Property but as it has increased in value and falls above his own Capital Gains Tax allowance, there will be Capital Gains Tax to pay. The son could use the Deed of Variation to transfer the Property into the joint names of himself and his wife, thereby using two Capital Gains Tax Allowances rather than just one – so reducing the tax bill.

Can a Deed of Variation help safeguard against losing my benefits?

Using a Deed of Variation probably won’t help in this case, as with means-tested benefits a person will likely be regarded as deliberately depriving themselves of assets and possibly assessed by the State as owning those assets. This applies even though they have in fact completely given their inheritance away. The State probably will not make a decision at the time the person comes into the inheritance, as they usually only assess the financial position of a person receiving benefits on their intended review date, say, every 5 years.

The risk to a person entering into a Deed of Variation to deprive themselves of their inheritance so they can keep their benefits as they were before the inheritance, may find that they have to give benefit monies back to the State. This could create great hardship, as they may not be in a financial position to do so and having gifted their inheritance they are unable to get this back.

In Conclusion

It is important to get a Deed of Variation right, as there are legal formalities and time frames to observe. You may be thinking of asking “do I need a Solicitor for a Deed of Variation?” and “how long does a Deed of Variation take?”.

The Deed of Variation is a powerful tool that needs to be bespoke to a person’s individual circumstances and this is why it is important to seek proper legal advice to ensure that it works in the way that you want it to. It usually takes 2 weeks to prepare a Deed of Variation from the time of receiving instructions.

If you feel that you need help in this area, contact Jensen Bourke today at Cunningtons
on 01273 725 229.

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