Many young people will find it harder to get their feet onto the property ladder and have been forced to rethink their plans to inherit the family home after the Government clamped down on a popular tax relief over Christmas, tax experts are warning.
Finance Minister Michael Noonan tightened up the rules around the dwelling house exemption – a tax break which allows houses and apartments to be inherited tax-free – in his latest Finance Bill. The rules were tightened in response to concerns that the exemption was being abused by wealthy people as a way of gifting properties to their children without triggering a tax bill.
How have the rules changed?
Capital Acquisitions Tax (CAT) of 33pc is typically paid by an individual who receives a gift or inheritance. It is more commonly referred to as gift tax or inheritance tax.
Receiving a gift of money or assets is different to receiving it as an inheritance – unlike inheritances, a donor is still alive when gifting something.
There are certain tax reliefs which allow people to receive gifts or inheritances without triggering a CAT bill. Before Christmas, it was possible to use one of these reliefs – the dwelling house exemption – to give a tax-free gift of a property to someone while the donor was still alive. There was no requirement for the individual receiving the property to be a relative of the donor. This is no longer the case.
Under the new rules, the dwelling house exemption can only be used to pass on a property tax-free if the individual passing that property on has died – unless the house is being gifted to a dependent relative. The Revenue Commissioners define a dependent relative as “a direct relative of the donor, or of the donor’s spouse or civil partner, who is permanently and totally incapacitated because of physical or mental infirmity from maintaining himself or herself – or who is over the age of 65”. So in most cases, the dwelling house exemption can now only be used for inheritances.
Another major change to the exemption is that any property inherited must have been the principal place of residence of the deceased person (that is, the person passing on the property) at the date of his or her death – apart from cases where ill health forced the deceased person to leave the house before he or she died (such as to live in a nursing home). Previously, the property being passed on didn’t have to be the donor’s main family home – it could have been a second property or a holiday home.
The only exception here is where the property is being gifted to a dependent relative: in such cases, the house does not have to be the principal private residence of the donor.
How is it harder to inherit the family home tax-free?
Before Christmas, it was much easier to use the dwelling house exemption to inherit a property tax-free. Broadly speaking, as long as the person inheriting the property had been living in the property as his main residence for at least three years -and continued to live there for six years after inheriting it, he could expect to qualify for the exemption. You must still meet those three- and six-year residence rules to be able to claim the exemption. However, you must now also meet the other new conditions which were introduced under the Finance Bill – and this will prevent many people from being able to claim the relief.
The new restrictions are already having an impact, according to Michael Gaffney, tax expert with KPMG. “Individuals and families take time to plan where they live, so plans to acquire a house tend to evolve over months or years,” said Gaffney. “There were a lot of people occupying houses belonging to their parents or other family, and waiting for the three-year period to end so that the house could be gifted to them. The change in law means they must now rethink their plans.”
The new rules will make it harder for many young people to get on the property ladder, according to Norah Collender, tax technical manager with Chartered Accountants Ireland.
“The dwelling house exemption allowed some parents to help their children to get onto the property ladder in a tax-efficient way,” said Collender. “It’s unusual that a tax break like this would be withdrawn when there’s so much attention on the need for homes today. It can be hard for the younger generation to get access to finance for properties.”
The Government has promised to make it easier for children to inherit the family home tax-free by increasing their inheritance tax thresholds, which allow them to inherit a certain amount of wealth from their parents tax-free over their lifetime. Although the Government increased the threshold for children from €280,000 to €310,000 in its latest Budget, many argue that this threshold is still very low – particularly for those inheriting family homes in Dublin where property prices are often well above €310,000. As 33pc inheritance or gift tax is due on the balance over €310,000, children can face crippling tax bills if left valuable family homes.
For this reason, it is not just the wealthy who will be impacted by the new rules, according to Gaffney. “In many parts of Ireland, an ‘ordinary’ house could be worth well in excess of €310,000,” said Gaffney. “The new rules will delay the passing of family homes. However, given that sooner or later everything must be passed on, there will eventually be many situations where the house will need to be sold to pay the tax.”
In recent years, inheritance tax bills have forced some children to sell the family home. The same is true of siblings – or others who have had properties left to them by a relatives. At €32,500, the tax-free threshold for siblings, nieces and nephews is much lower than the €310,000 threshold for children. So the tax bills faced by siblings, nieces and nephews after inheriting property is often much higher and could run to €100,000 or more.
How to chop your inheritance tax bill
One of the most important things you can do to reduce your inheritance tax bill – or the tax bill faced by those that you will leave something to – is to plan to ahead, according to Collender.
“Business relief or agricultural relief are valuable tax reliefs when it comes to passing on businesses to the next generation – but you must meet various conditions and rules to be able to claim the relief,” said Collender. “It is important for family members to talk over future plans about when they want to retire – and what they want to do in life. For example, does a child really want to carry on the family business or keep the family farm? The tax reliefs for the transfer of a family farm or business are dependent on the child retaining or running the business for six years after the inheritance or gift.”
If you have decided to give money or other assets to your children, do so sooner rather than later – assuming the tax is affordable, advised Gaffney. “Over the years the assets of the parents will likely grow in value – and the [inheritance tax] problem gets bigger,” said Gaffney. “If you as parents feel that your children are not quite ready to receive such money or assets and so you want to retain some control over the assets, this can be done. It’s not unusual for gifts to be made with conditions that assets cannot be sold, or funds depleted.”
The annual small gift exemption, which allows a child to get €6,000 worth of tax-free gifts from his or her parents a year, is useful if you wish to drip-feed your inheritance while alive. With this exemption, one individual can give tax-free gifts of up to €3,000 a year to another.
“Two parents could gift €12,000 in total each year to each child and their respective partner – such as a fiancée or son-in-law -free of inheritance tax,” said Collender. “This was used in recent times by parents assisting children with debt or mortgage difficulties. Gifts which qualify for the small gift exemption do not reduce the tax-free thresholds either.”
Ireland’s inheritance tax is one of the highest in the world – but careful and early planning can limit how much it takes out of your pocket.
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