What are Gifts with reservation? – How they impact IHT Planning

When it comes to inheritance tax (IHT) planning, most people naturally want to preserve as much of their wealth as possible for their family and loved ones. And rightly so, after a lifetime of hard work, you want to pass on your legacy, not lose a large portion of it to the taxman.

But the reality is without proper planning, even modest estates can face significant IHT bills. One common, and costly mistake is gifting your home while continuing to live in it. This may fall foul of the IHT rules, known as a “gift with reservation of benefit” and it’s a trap that catches out well-meaning families.

Let’s break it down. 

What is a gift with reservation?

Put simply, a gift with reservation happens when you give something away but still keep some benefit from it.

The classic example? Parents transferring their main residence to their children but continuing to live there rent-free. While this may seem like a clever way to reduce the value of your estate, HMRC doesn’t see it as a true gift, and they’ll treat it as though you never gave the property away at all.

As one judge famously put it: ‘not only may you not have your cake and eat it, but if you eat more than a few de minimis crumbs of what was given, you are deemed for tax purposes to have eaten the lot.’

How do they affect inheritance tax liability?

Under current rules, if a gift is deemed to include a reservation of benefit, the full value of that gift is pulled back into your estate for IHT purposes, no matter how long ago it was made.

That means the usual 7-year rule (where gifts fall outside your estate after 7 years) doesn’t apply. Instead, the asset could still be taxed at up to 40% on your death.

Compare that with a genuine gift:

If you give away an asset to an individual and retain no benefit, and survive seven years, the gift is likely to be completely outside your estate. These are called Potentially Exempt Transfers (PETs). 

How it works in practice

Let’s say in 2025, John gifts his £600,000 home to his daughter but continues living there rent-free. He passes away in 2032.

Even though seven years have passed, HMRC will treat the house as still being part of his estate, because he kept living there without paying rent. That could mean a £240,000 tax bill (40% of £600,000) on the home alone.

Now imagine John had paid full market rent from the start. In that case, the gift would be considered a genuine PET. Provided he lives for seven years, no inheritance tax would be due on the property. 

How can you gift the family home, properly?

If you’re thinking of passing on your home but still want to live there, you must pay full market rent to avoid it being a gift with reservation. That rent should be backed up with a formal agreement and reviewed regularly to reflect market rates. 

There’s a silver lining here: paying rent can actually help reduce your taxable estate by reducing your cash reserves. But of course, the rent becomes taxable income for your children, so this needs to be factored in.

Holiday homes count too: if you gift one but still use it occasionally, you should pay market rent for each use, or HMRC may challenge it. 

What about Capital Gains Tax (CGT)? 

Gifting an asset, especially one that has increased in value, can also trigger Capital Gains Tax (CGT), which adds another layer of tax complexity.

• If the property is your main residence, CGT usually isn’t payable when you gift it.
• If it’s a second home or investment property, CGT could apply on the gain at the point of gifting.

Here’s a twist: if you hold onto the property and pass it on when you die, your heirs benefit from a Capital Gains Tax uplift, the property is revalued at the date of death, which can significantly reduce CGT if they sell it later.

But if you make a gift with reservation, your estate may still be taxed as if you owned the asset, but your heirs won’t benefit from that CGT uplift. It’s the worst of both worlds. 

Moving into care – does that change things?

If you’ve gifted your home but still live in it rent-free, it’s a gift with reservation.

However, if you later move permanently into a care home, you no longer benefit from the property. From that point, the 7-year PET clock starts.

But here’s the catch: research from the Office for National Statistics (ONS) showed the average stay in a care home is between 2 to 7 years, so it’s statistically unlikely that moving into care will make the gift effective for inheritance tax planning, unless you move fairly soon after the gift.

On the other hand, if you were paying market rent from the beginning, your 7-year clock already started when the gift was made, and moving into care has no impact on the IHT position.

⚠️ Note: Gifting your home to avoid paying for care fees could be seen as deliberate deprivation of assets. Local authorities can investigate this and may still assess you as owning the property. 

2025/26 Inheritance tax thresholds recap

Nil-Rate Band: £325,000 – the standard IHT-free allowance, frozen until 2031.

Residence Nil-Rate Band (RNRB): £175,000 – available if you leave your home to direct descendants (children, grandchildren, etc.). Starts tapering once your estate exceeds £2 million.

Married couples and civil partners can combine allowances. That means a couple could potentially pass on up to £1 million tax-free if they qualify for both the nil-rate and residence nil-rate bands. 

Why the residence nil-rate band changes the game

Since the introduction of the RNRB, fewer people need to gift their home to their children during their lifetime. That’s because doing so could mean losing access to this valuable allowance.

By retaining your home and planning more strategically with your liquid assets, such as cash or investments, you may be able to reduce your IHT exposure without falling into the gift with reservation trap.

For example, making gifts from surplus income or investment portfolios, and retaining the family home to benefit from the RNRB, is often a more effective strategy. 

How we can help

Estate planning is complex, and what works for one person may not be right for another. Gifting your home might seem like a smart move at first glance, but without careful planning, it could land your estate with an unexpected tax bill.

If you’re considering giving away your property or want to understand your options for reducing inheritance tax, it’s crucial to get professional advice early.

If you’d like help navigating the latest inheritance tax rules and exploring the best options for your estate, we’re here to help. Book your free initial consultation with one of our advisers today and start your planning with confidence. 

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The Financial Conduct Authority (FCA) does not regulate cash flow planning, estate planning, tax or trust advice. 

This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.