Can I use a trust to pass my property to my two adult children?

I'm a single parent, and am looking at ways to minimise inheritance tax on my estate when I die.

I looked into passing my home to my adult son and daughter while I am alive, but it seems that as I am not in a couple, my options are limited - especially when it comes to property trusts.

I understand that I could do things like sign the deeds over to them, but would this add financial complications?

What trusts are available to me? What other options are there? L.P, via email

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Harvey Dorset, of This is Money, replies: Transferring a property to your children during your own lifetime is possible, but if you want to keep living there the risk of falling into an inheritance tax (IHT) trap is high.

It could be deemed a 'gift with reservation of benefit' by HMRC, which means it would levy inheritance tax anyway, unless you jumped through various hoops including paying market rent to your children.

You children could face tax complications of their own, which they should get advice about. And if they got divorced or went bankrupt you could even find your home being sold out from under your feet.

Meanwhile, you might think one benefit of renting rather than owning a property in older age is you are less likely to meet the £23,250 asset threshold at which your local authority would step in to help if you needed residential care.

However, your council might decide you gave your property away deliberately in order to avoid paying for care, opening up another can of worms.

There is no time limit on it doing this, and if it deems 'deprivation of assets' took place you can be charged for care as if you still owned your home.

You mention wanting to use a trust to pass on the property instead, which in itself could prove difficult due to the fees and charges involved.

This is Money spoke to two financial advisers to find out what options are open to you, and where you need to look for guidance on this complex issue.

> How inheritance tax works - and what families MUST know

Chris Peters, independent financial adviser at Flying Colours, replies: For the purposes of this piece, I am assuming your estate, including your property and any other cash, investments or taxable assets, exceeds the value of £500,000 but that it does not exceed £2million.

In this case, your IHT allowance is £500,000. This is made up of the £325,000 nil-rate band, the amount anyone can pass on to descendants tax-free, and the £175,000 residence nil-rate band, which is granted to people passing their main home on to their direct descendants.

Any assets in your estate above this amount will be subject to a 40 per cent IHT rate.

There are several options, but the right one is dependent on personal circumstances.

As you have identified, being a single parent and owning the property solely means one of the popular types of property trust, a Property Protection Trust, is not suitable for you.

This is designed for couples, who want to leave their home to their children but for the surviving partner to be able to keep living in it.

You could consider an alternative type of trust. However, to ensure your estate doesn't get caught by inheritance tax, you may need to pay rent at the market value.

This is because, if you stay in the property for free, it could be considered a 'gift with reservation of benefit' - which isn't allowed under IHT rules.

To stay within the rules, the money you use to pay rent would be from your own taxable income, and the trustees would also have to pay 45 per cent tax on the income going into the trust – so effectively, it would incur tax twice.

If you were to gift into a Discretionary Trust, this would be treated as a chargeable lifetime transfer (CLT).

A CLT is a gift made during an individual's lifetime, which is immediately chargeable to IHT.

This does not necessarily mean that there will be IHT to pay, but it would have to be assessed to see if a charge to IHT will arise. If the gift is within the available nil rate band (NRB), then there will be no IHT due immediately.

If the gift is above the NRB, then the charge applied is at the lifetime rate of 20 per cent. However, if you die within seven years of making a CLT, it will be brought into the IHT calculation and tax will be re-calculated at the full rate of 40 per cent.

Additionally, discretionary trusts may be subject to periodic charges up to 6 per cent every 10 years (if above the £325,000 trust NRB) and when capital is paid out.

The transfer of assets into and out of the trust will be a disposal for capital gains tax (CGT) purposes. The trust rate for capital gains is 24 per cent for residential property. So, there is a lot of consideration required before deciding that a discretionary trust is the right solution for you.

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The alternative option is to use a Deed of Gift, where you legally pass all or part of the property to your children without any payment or exchange in return.

This process exempts the recipients from paying stamp duty, CGT or income tax on the property value.

Gifts are considered potentially exempt transfers. This means that if you survive for seven years, the gift is exempt, but if you die within seven years, it might still be included in your estate for IHT calculations.

If you gift more than £500,000 within seven years, the excess amount may be subject to IHT, either immediately (if it's a chargeable lifetime transfer) or when you die (if it's a failed potentially exempt transfer).

Think about care home fees

Gifting your home might reduce your IHT bill, but it can also raise other complications.

If you gift your house and later apply for means-tested care, your local authority may investigate your financial history. If they believe the gift was made to reduce your assets and qualify for support, they can treat it as a 'deprivation of assets'.

In this case, the council could still include the value of the home in their financial assessment, meaning you'd be expected to pay for your care as if you still owned the property. This applies regardless of how many years have passed since the gift was made, as there is no fixed time limit on the deprivation of assets rules.

You could also downsize and gift the proceeds – although you would need to survive seven years for the gift to fall outside your estate for IHT purposes.

I would always advise you to seek independent professional advice to guide you through this process, as IHT and trusts are a notoriously complex area.

Lisa Caplan, director of Charles Stanley direct advice & guidance, replies: Options for gifting property in your lifetime are limited. Trusts can be useful, but the regulations around them have made them less useful for minimising inheritance tax.

Your position differs depending on whether the property you are thinking of giving to your children is your own home, where you live, or if it is another property or properties.

There are a series of 'gift with reservation' rules, which make it difficult to make a gift (even to a trust) of your home, if you continue to live in it.

However, you may be exempt from this if you:

• Continue to live in the property but pay full market rent to your children

• Jointly occupy the house with the recipients and continue to pay your fair share of the household expenses.

In addition, be aware transferring your home may impact the ability of your executors to claim the residence nil rate band of £175,000 for IHT on your estate, especially if it is held by a trust.

If it's not your home, it can be much more straight forward so long as you are prepared to lose control of the asset. Transferring a holiday or rental property to your children is a gift and becomes exempt from IHT after seven years.

Rental income would go to the children and be taxed accordingly, and if you use the holiday home, you should pay them the market rate.

Also keep capital gains tax in mind. It is payable by you on the profit you have made on the property other than your home at the point you make the gift.

This is at either 18 per cent or 24 per cent or a combination of both depending on whether you are a basic or higher rate taxpayer.

Trusts can be useful in mitigating inheritance tax, but they can be complicated and costly. The most commonly used is a discretionary trust.

A trust is a legal structure that will have at least three components:

1. The settlor, the person gifting the property to the trust

2. The trustees who administer the trust and have discretion about who it pays out to

3. Beneficiaries, who are ultimately entitled to the assets

There are legal costs involved in setting up a trust, and the trustees are required to register the trust with HMRC and complete regular tax returns for it.

There may be regular reporting requirements and possible IHT payments on the trust's 10-year anniversary and when payments are made to the trust's beneficiaries.

Transfers to a trust are usually regarded as chargeable lifetime transfers which are subject to IHT when they're made, but they won't always result in a tax liability.

This is because you can use your nil rate band allowance of £325,000 to reduce the amount of tax payable. Gifts above this amount are taxed at 20 per cent.

Using your nil rate band for this means it will not be available for other gifts or CLTs made in the next seven years. If you die within the next seven years IHT will be recalculated at the death rate and your estate will be liable for the difference.

If you live for another seven years, there is no further tax liability, and your £325,000 allowance becomes available once more. You cannot reclaim the 20 per cent already paid.

One other option is to set up a company that owns the property and you and your children would own shares in it.

This can be useful tool for property investors, but like with trusts, there are legal and administrative costs, and tax reporting as well. There may also be capital gains tax on transfer of the property into the company.

Whatever you choose to do, it is vital that you get professional advice. This subject is complex and best approached with the help of a solicitor and a financial adviser.