Gifts with Reservation of Benefit: How to Avoid This Costly Inheritance Tax Trap (UK)

Are you thinking about gifting your home to your children to reduce Inheritance Tax, but you'd still like to live there? It's one of the most common questions we hear at Westwood Estate Planning, and for good reason. The idea seems straightforward: give away your property now, continue living in it, and reduce the size of your taxable estate. Everyone wins, right?

Unfortunately, this is where many well-intentioned people unknowingly walk straight into one of the most expensive Inheritance Tax traps: the 'Gift with Reservation of Benefit.' And the consequences can be devastating for families who discover, after a loved one has passed away, that their careful planning didn't work at all.

In this guide, we'll explain exactly what this trap is, why it catches so many people out, and—most importantly—how you can genuinely gift assets to your family without falling into it.

What Actually Happens: A Gift That Isn't Really a Gift

Let's consider a real-world scenario that plays out regularly.

Susan, concerned about Inheritance Tax, decides to gift her £400,000 home to her two daughters. The property is legally transferred into their names. Susan feels relieved—she's just removed £400,000 from her taxable estate, potentially saving her family £160,000 in Inheritance Tax.

But here's the problem: Susan continues living in the house exactly as before. She doesn't pay her daughters any rent. She pays the bills, maintains the property, and to all intents and purposes, nothing has changed in her day-to-day life.

When Susan passes away eight years later, her family is shocked to discover that HMRC treats the house as still being part of her estate. The full £400,000—or its value at death—is included in the Inheritance Tax calculation. The family faces the £160,000 tax bill Susan was trying to avoid, but now they don't even own the house—the daughters do—creating a complicated mess to sort out.

This is a 'Gift with Reservation of Benefit,' and it's exactly what the rules are designed to prevent.

Why Does This Rule Exist?

The principle is actually quite straightforward. HMRC's position is this: if you give something away but continue to enjoy all the benefits of owning it, then you haven't really given it away at all. You can't have your cake and eat it too.

The legislation—Section 102 of the Finance Act 1986 and Schedule 20 to the Finance Act 1986—ensures that people can't simply shuffle assets around on paper while their actual circumstances remain unchanged, purely to avoid tax.

And while that might seem harsh, especially when your intentions are good, it's a line HMRC enforces strictly.

Why This Trap Is So Costly

The reason this catches people out so badly is that it delivers the worst of both worlds:

You've given away legal ownership and control of your asset. Your children now technically own your home. If they face financial difficulties, divorce, or bankruptcy, that asset is at risk because it's theirs, not yours. You've lost the protection ownership provides.

Yet despite giving away control, you've achieved absolutely no Inheritance Tax saving. The asset is still counted as part of your estate when calculating the tax bill. Your family gets hit with the full 40% tax rate on that asset's value.

This isn't just a theoretical problem. We've seen families devastated by this—having to sell properties they thought were safely protected, or scrambling to find hundreds of thousands of pounds to pay an unexpected tax bill.

How to Genuinely Gift Your Home Without the Trap

The good news is that you can legitimately gift your home and reduce your Inheritance Tax liability. You just need to do it properly. There are several main ways to avoid the 'reservation of benefit' trap.

1. Move Out Completely

The simplest approach is to genuinely give away your home and move out entirely. If you gift the property to your children and then go and live somewhere else—whether that's a rented flat, a smaller property you purchase, or even with other family members—then there's no reservation of benefit. The gift is clean, and after seven years (assuming you survive that long), it's completely outside your estate for Inheritance Tax purposes.

This works because you've genuinely relinquished all benefit from the property. You're not using it at all.

2. Continue Living There—But Pay Market Rent

If you want to continue living in your home after gifting it, you must pay your children—or whoever you gifted it to—a full market rent. And this isn't just a token gesture. The rent must be:

Truly commercial: What would an independent tenant pay for the property? If market rent for a similar property in your area is £1,500 per month, that's what you need to pay. Not £500. Not 'a contribution.' The full amount.

Paid regularly and consistently: Monthly standing orders that you can evidence to HMRC if required.

Properly documented: A formal tenancy agreement between you and the new owners, just as if you were renting from a landlord you didn't know.

Reviewed annually: Market rents change. Your rent needs to keep pace to remain legitimate.

If you follow this approach, you're paying for the benefit you're receiving, which means there's no 'reservation' of benefit. You're a tenant, paying rent like any other tenant would.

We won't sugarcoat it: this feels strange to many people. You're paying rent to your own children to live in what used to be your home. But it's the price of making this strategy work legitimately.

Important tax consideration: Your children will need to declare the rental income and pay income tax on it, which could affect the overall tax efficiency of this arrangement. Make sure you factor this into your planning.

3. Share the Property (In Certain Circumstances)

In limited circumstances, you may be able to gift a share of your property while continuing to live there without triggering the reservation of benefit rules—but only if you and the person you've gifted to both occupy the property and you both meet your share of the running costs proportionately.

For example, if you gift a 50% share to your child and they genuinely live in the property with you, sharing the space and contributing their proportionate share of bills and maintenance, this may avoid the trap. However, this is a complex area with strict requirements, and professional advice is essential.

4. Consider Alternative Strategies

Gifting your home isn't the only way to reduce Inheritance Tax. Depending on your circumstances, other strategies might be more appropriate, such as:

• Taking out life insurance in trust to cover the tax bill

• Making smaller gifts using your annual exemptions and normal expenditure out of income exemptions

• Setting up trusts for other assets

• Ensuring you use available reliefs like Business Property Relief where applicable

The Seven-Year Rule Still Applies

It's important to understand that avoiding the 'reservation of benefit' trap doesn't mean the gift is immediately outside your estate. The gift itself is still a Potentially Exempt Transfer (PET), which means you need to survive seven years after making it for it to be completely Inheritance Tax-free.

If you die within seven years, the gift's value is brought back into your estate for Inheritance Tax purposes, though taper relief may reduce the tax charge if you survive more than three years.

However, if there is a reservation of benefit, this seven-year countdown never even starts because the asset is treated as still being in your estate regardless of when you die. Avoiding the reservation trap is the essential first step.

Record Keeping: Your Family's Protection

Just as with every aspect of Inheritance Tax planning, meticulous records are absolutely critical here. If HMRC investigates your estate after you pass away, your executors will need to prove that no reservation of benefit existed.

This means keeping:

• Complete documentation of the gift itself (property transfer documents, deed of gift, Land Registry records)

• If you're paying rent: a formal tenancy agreement, evidence of every rent payment made, annual rent reviews, and proof that the rent was at market rate (estate agent valuations can help here)

• If sharing the property: evidence of your child's genuine occupation and their contributions to running costs

• Any correspondence relating to the arrangement

• Professional advice you received when setting up the arrangement

Without solid records, even a perfectly compliant arrangement can be challenged by HMRC. And when that happens, it's your family who'll face the consequences and stress of trying to prove everything was done correctly.

The Conversation Worth Having Now

Here's what we'd encourage you to think about: if you're considering gifting your home to reduce Inheritance Tax, the question isn't just whether you can do it. It's whether it's the right strategy for your specific circumstances.

For some families, genuinely moving out or paying market rent works well. For others, there are better ways to reduce Inheritance Tax that don't require giving away your home at all—and don't expose your most valuable asset to the risks that come with giving away ownership.

This is exactly why we offer a free, no-obligation 15-minute conversation. It's not a sales pitch. It's an opportunity to talk through your situation, understand what's actually possible, and make sure any steps you take will genuinely protect your family—not create expensive problems down the line.

You can book a time that suits you right here on our website. Let's make sure your estate planning actually works.