Pre-Owned Asset Tax (POAT): How to Prevent the Charge on a Gifted Property

Thinking of gifting your home, or a share of it, to your children while carrying on living there yourself? At first glance, it may look like the perfect plan. You take value out of your estate, you stay in the house you have always lived in, and the next generation inherits sooner rather than later. So where is the catch? The catch is that HMRC has seen this arrangement many times over, and it has built more than one set of rules to deal with it.

Gifting property that you continue to live in or use can trigger several tax risks. The two principal anti-avoidance regimes are the gift with reservation of benefit rules (GWR), which can pull the property straight back into your estate so that the inheritance tax position is left unchanged, and the Pre-Owned Asset Tax (POAT), an annual income tax charge that can apply where you have given away property, cash or other value but continue occupying or enjoying property connected with that gift. Capital gains tax, stamp duty land tax, and residence nil-rate band issues can also arise.

This article focuses on POAT and explains the main routes by which both GWR and POAT may be avoided, provided the relevant conditions continue to be met.

The gift with reservation rules apply where an individual gives away property but continues to enjoy a benefit from it. In that situation, the property may still be treated as part of the donor’s estate for inheritance tax purposes, even though legal ownership has passed to someone else.

If the donor continues to benefit from the property until death, the property is included in their estate at its value at that time. Taper relief does not apply because the property is treated as part of the death estate rather than as a lifetime transfer.

If the donor stops benefiting from the property during their lifetime, the seven-year period starts from the date the benefit ends, rather than from the date of the original gift. If the donor dies more than three years but less than seven years after that date, taper relief may reduce any inheritance tax payable.

POAT applies where you occupy a property, and either the disposal condition or the contribution condition is met, provided the relevant transaction occurred after 17 March 1986 and was not an excluded transaction. The two conditions are outlined below:

The charge is calculated by reference to the open-market rental value of the property, adjusted to reflect the proportion attributable to the interest disposed of or the contribution previously made by the occupier, where relevant. That amount is added to your taxable income and taxed at your marginal rate. So, if the relevant annual rental value is £20,000 and you are a higher rate taxpayer, the annual income tax charge would be £8,000 at a 40% rate. If you are an additional rate taxpayer, the charge would be £9,000 at a 45% rate. Different rates may apply to Scottish taxpayers.

There is a de minimis exemption where the aggregate relevant POAT benefit for the year does not exceed £5,000. The test is based on the appropriate rental value of the property, before deducting rental payments (if any). If the relevant amount exceeds £5,000, the exemption is lost altogether.

Crucially, even if you eventually move out, the charge runs for every year you were in occupation. There is no retrospective exemption once POAT has applied. You cannot simply decide to move out and escape the charge for the years you were there. The charge accrues as you go, and you are responsible for declaring it on your tax return for each year of occupation.

If you gift cash rather than the property itself, the GWR provisions do not normally apply to the property that the recipient buys with that cash. You never owned the property, so how can you have reserved a benefit in it? This argument may appear plausible, and arrangements structured in this way can fall outside the GWR rules.

However, POAT can apply even if you never owned the property yourself.

For POAT purposes, what matters is that the cash or other value came from you, the recipient used it towards acquiring the property, and you later occupied that property.

For example, you may give cash to your child, your child uses that money to buy a property, and you later move into it. POAT may apply because your gift helped fund the purchase of the property you now occupy.

The same principle can apply where the connection is indirect. For example, your child may use your cash gift to buy another asset, later sell that asset, and use the proceeds to buy the property you occupy.

The seven-year exclusion

A limited exclusion may apply where the contribution was an outright gift of money made at least seven years before you first occupied the property. Money, for these purposes, means cash. So, the exclusion does not apply where you gave another asset that was later sold, or where you made a loan that was subsequently written off.

Example

A parent gives a child £300,000, which the child uses to buy a property. If the parent moves into the property three years later, POAT may apply for each year of occupation.

If the contribution was an outright cash gift made at least seven years before the parent first occupied the property, the gift may fall within the seven-year exclusion, and POAT may not apply.

To understand how the rules developed, consider the Lady Ingram case.

In 1987, when she was aged 72, Lady Ingram owned a country house in Berkshire where she had lived for more than 40 years. She wanted to give the property to her children and grandchildren to reduce the inheritance tax on her estate, but she had no intention of leaving the house.

Her advisers devised an ingenious solution. Lady Ingram conveyed the property to her solicitor, who granted her a 20-year lease. The solicitor then transferred the freehold reversion, being the ownership that would revert when the lease ended, to the family trustees. In this way, Lady Ingram kept the lease, which gave her the right to occupy the house, and gave away only the freehold reversion.

The argument was elegant: what she gave away was the freehold subject to the lease. What she retained was the lease itself. Because she never gave away the lease, she could not have reserved a benefit in something she gave away. She had divided the cake before sharing it.

The House of Lords agreed with her on 10 December 1998 in Ingram v IRC [1998] UKHL 47, [1999] STC 37 and [2000] 1 AC 293. No reservation of benefit had arisen. For a brief moment, the Ingram scheme looked like a legitimate route to giving away property while staying in it.

Parliament responded quickly. Legislation applying to arrangements made on or after 9 March 1999 introduced section 102A of the Finance Act 1986 to catch arrangements of this type. Ingram-style schemes entered into on or after that date can therefore be treated as gifts with reservation. Older arrangements may instead fall within POAT, depending on the facts.

The GWR rules come first and operate for inheritance tax purposes. POAT is the later-introduced income tax alternative that Parliament created because certain arrangements fell outside GWR.

The two charges do not normally apply to the same benefit from the same asset at the same time. The POAT legislation contains exemptions intended to prevent an overlapping charge where the relevant property is already subject to the GWR rules. It also recognises certain statutory GWR exceptions, including the shared-occupation exception in section 102B(4).

Understanding which regime applies is essential because the outcomes can be materially different. Under GWR, the property may remain within the donor’s estate for inheritance tax purposes. Under POAT, the donor may instead face an annual income tax charge for each year of occupation.

Not all gifts of property trigger GWR or POAT. There is a powerful statutory safe harbour under section 102B(4) of the Finance Act 1986, designed for cases where you give away a share of a property but both you and the recipient genuinely continue to live there.

Section 102B(4) disapplies the GWR charge where two conditions are met:

(a) the donor and the donee occupy the land; and

(b) the donor does not receive any benefit, other than a negligible one, which is provided by or at the expense of the donee for some reason connected with the gift.

In simpler terms: both parties genuinely live in the property, and the donor is not being subsidised by the donee as a result of the gift.

Where these conditions are satisfied, the gift of the share is not treated as a gift with reservation. Because POAT does not apply where property would be caught by GWR but for this express exception, Schedule 15 paragraph 11(5)(c) of the Finance Act 2004 also brings the property within the POAT exemption. Neither GWR nor POAT arises.

The critical point is that the cohabitation requirement is not a one-off test passed on completion day. Section 102B(4) is a continuing condition. The relief holds only for as long as both donor and donee continue to occupy the property and the no-benefit condition is satisfied. If the donee ceases to occupy the property as their home, or if cost-sharing shifts so that one party subsidises the other, the protection may fall away from that point. A brief or temporary physical absence will not necessarily be decisive, but any material change in occupation should be reviewed.

David and Sarah own their home in equal shares, and the property is valued at £2.1 million. Their adult son James has always lived with them. David and Sarah decide to gift a 50 per cent beneficial interest in the property to James.

Why this works

Each parent’s gift of their share of the interest to James will be a potentially exempt transfer. If they survive seven years and no reservation arises, the gifts will generally fall outside their estates.

GWR does not apply because all parties continue to occupy the property and no collateral benefit flows from James to David and Sarah by reason of the gift. Section 102B(4) of the Finance Act 1986 is satisfied. David and Sarah’s continued occupation of their retained interest is not at James’s expense and does not detract from his enjoyment of his share.

POAT does not apply because section 102B(4) is satisfied, which means Schedule 15 paragraph 11(5)(c) of the Finance Act 2004 brings the property within the POAT exemption.

Documentation recommended to defend this position:

At the date of the gift: the transfer deed, Land Registry documentation showing the ownership split, a professional valuation of the interest transferred, mortgage lender consent where applicable, and evidence that James occupied the property.

Annually thereafter: a written confirmation of continued occupation and cost-sharing, bank statement evidence of the payment of outgoings, and a file note confirming why section 102B(4) continues to apply.

On David and Sarah’s deaths, HMRC may review the gift as part of the inheritance tax reporting. With a complete evidence file in place, the position should be easier to defend.

Where you pay full open-market rent, GWR and POAT may both be avoided. But the rent must be a genuine market rent, reviewed regularly and evidenced by formal occupation and payment records. HMRC may challenge nominal or below-market arrangements.

For GWR purposes, Schedule 20 paragraph 6(1)(a) of the Finance Act 1986 provides that occupation for full consideration in money or money’s worth is disregarded when determining whether there is a reservation. The parties should obtain an independent rental valuation and enter into a tenancy agreement, licence or other occupation agreement appropriate to the circumstances.

The rent should be paid regularly and reviewed at suitable intervals against current comparable rents. If the rent is not reviewed and later falls below the full market rate, a GWR may arise from that point.

For POAT, payments that you are legally required to make to the owner for occupying the property reduce the chargeable amount. If those qualifying payments equal or exceed the appropriate rental value, the POAT chargeable amount will normally be nil. Where the full-consideration exception to GWR applies to the gift itself, Schedule 15 paragraph 11(5)(d) of the Finance Act 2004 may also provide a specific POAT exemption.

The rent received will ordinarily be taxable property income of the recipient and must be reported to HMRC where required. This income tax cost should be taken into account when assessing whether the arrangement is suitable.

A person who first becomes liable to POAT may be able to elect for the relevant property to be treated under the inheritance tax GWR rules instead.

For land, the election must normally be made by 31 January following the first tax year in which the person is chargeable to POAT. It cannot be made if the person was already chargeable in an earlier year in relation to the same property or substituted property.

The election takes effect for inheritance tax purposes from the date on which the POAT charge would first have arisen, but not earlier than 6 April 2005. From that date, the relevant chargeable portion of the property is treated as property subject to a reservation, and the corresponding POAT income tax charge does not apply.

The election may be withdrawn or amended before the relevant filing date.

As the election is made individually, each spouse or civil partner must decide if they each wish to avoid the POA charge.

Beyond GWR and POAT, gifting property creates other tax and legal risks that must be reviewed.

Pre-Owned Asset Tax is one of the most misunderstood tax charges affecting property owners. The temptation to gift cash rather than the property itself, or to gift a share of the home while staying in it, feels commercially sensible and is often well-intentioned. But without the right structure, documentation and ongoing compliance, the arrangement can expose you to a hidden annual income tax charge, running for every year you occupy the property and taxed at your marginal rate.

Getting the structure right is essential. If you have already made an arrangement of this kind, establishing quickly whether GWR or POAT applies is important. If you are considering a property gift, taking proper advice before you act can make a significant difference to the outcome.