What are gifts with reservation? Understanding the inheritance tax rules...

Some common examples of gifts with reservation

Giving away your home but continuing to live there

One of the more common examples of gifts with reservation is a parent giving their home to their children but continuing to live there.

Although legal ownership of the property has changed, the parent is still benefiting from it by continuing to occupy the property. If that benefit continues until their death, the property will generally be treated as forming part of their estate for inheritance tax purposes and included at its market value at the date of death, rather than its value when it was originally gifted.[2] This is why simply transferring your home to your children and surviving seven years does not, by itself, necessarily achieve the intended inheritance tax saving.

There are circumstances in which someone can give away a property and continue to occupy it without creating a reservation of benefit. Broadly, this can apply where the donor provides full consideration in money or money’s worth for their continued occupation. For example, a genuine commercial arrangement involving rent may, depending on the circumstances, satisfy this requirement. HMRC’s guidance indicates that the precise facts are important, including whether the arrangement was negotiated at arm’s length and followed normal commercial criteria.

This should not, however, be viewed simply as a way of “getting the house out of the estate”. The circumstances of the arrangement matter, and the donor needs to consider whether giving away the property, losing control of it and then paying for the right to occupy it is appropriate for them.

There may also be wider financial and tax considerations. For example, the donor needs to be comfortable with the ongoing cost of occupation, while the recipient becomes the owner of the property and takes on the associated responsibilities.

Giving away an asset but continuing to use it

The same principle can apply to personal possessions. HMRC gives the example of someone giving away a caravan but continuing to use it for holidays, or giving away a valuable painting while continuing to display it in their home. In these circumstances, the donor has given away the asset but has retained a benefit from it.

The exact circumstances will need to be considered, but the underlying principle is that the donor should genuinely give up their benefit from the asset.

Why do the rules exist?

The rules are designed to prevent someone from reducing the value of their estate for inheritance tax purposes while continuing to enjoy an asset as though they still owned it.[3]

Without the GWR provisions, someone could potentially give away a valuable asset, continue to benefit from it during their lifetime and still achieve an inheritance tax saving after seven years. The legislation therefore looks beyond the legal ownership of an asset.

What happens to the seven-year rule and gifts with reservation?

A lifetime gift to an individual will generally be a Potentially Exempt Transfer (PET). If the donor survives seven years from the date of the gift, the gift can become exempt from inheritance tax.[4] A gift with reservation is different.

If the donor continues to benefit from the asset, it can remain within their estate even if seven years have passed since the original gift. If the reservation is still in place when the donor dies, the property is generally treated as part of their estate at that point.

If the reservation ceases during the donor’s lifetime, the position changes. The gift is treated as a PET from the date the reservation ceases. If the donor then survives seven years from that date, the PET can become exempt in the usual way.[5]

So, when considering a gift, it is not enough to ask when it was made. It is also important to consider whether the donor continues to benefit from the asset and, if so, when that benefit ends.

What about trusts?

Trusts can form part of wider estate planning, but transferring assets into trust does not automatically remove them from your estate for inheritance tax purposes.

If the person making the transfer retains a benefit from the assets, the GWR rules may still apply. There can also be separate inheritance tax and other tax considerations depending on the type of trust and the circumstances.

Trust planning therefore needs to be considered as part of the wider estate plan rather than as a standalone solution.

What else should you consider before making a gift?

The potential inheritance tax saving is only one part of the decision.

There may be Capital Gains Tax and other tax implications depending on what you are gifting and to whom. There are also practical considerations. Once an asset has been given away, you no longer have the same control over it. The recipient may decide to sell it, their circumstances may change, or the asset could become affected by their own financial or personal circumstances.

You also need to be confident that you can afford to make the gift. Giving away cash, investments or other valuable assets may reduce the value of your estate for inheritance-tax purposes, but those assets will no longer be available for you to use or sell to fund your lifestyle, meet unexpected costs or pay for care later in life. In addition, if assets are given away deliberately to reduce the amount you may have to contribute towards future care costs, a local authority may treat you as still owning those assets when carrying out a financial assessment for care, depending on the circumstances.

This is why lifetime gifting needs to be considered as part of your wider financial plan. Depending on your circumstances, there may be a range of ways to pass wealth to the next generation, including making use of available exemptions and allowances, as well as considering pensions, investments, trusts and property. While pensions can still play an important role in estate planning, it is worth noting that from 6 April 2027, most unused pension funds and pension death benefits will be brought within the value of a deceased person’s estate for inheritance tax purposes, potentially reducing some of the inheritance tax advantages that pensions have historically offered.[6]

For some people, making substantial lifetime gifts may be appropriate. For others, retaining access to their capital may be more important, particularly where there is uncertainty about future spending or care needs.

Effective and appropriate estate planning is therefore not simply about reducing an inheritance tax bill. It is about finding an approach that allows you to pass on wealth while retaining the financial security and flexibility you need during your own lifetime.

Final thoughts

The gift with reservation rules are an important reminder that giving an asset away and giving up your benefit from it are not necessarily the same thing.

If you are considering making a significant lifetime gift, it is worth looking at the wider implications alongside the potential inheritance tax benefit. Will you still have enough capital to meet your own needs? Are you comfortable giving up control of the asset? And is gifting actually the most appropriate way of achieving what you want for your family?

These are important questions to consider before making a substantial gift. If you are considering inheritance tax planning speaking to a financial adviser is recommended.