Tax pitfalls loom as terminally ill brother considers using home to fund trust for adult son

A terminally ill man’s plan to transfer his home to a relative to fund a trust for his adult son has prompted tax experts to warn of potential pitfalls. Heather Rogers, founder of a leading tax column, says the approach carries clear financial and legal risks that could complicate both the donor’s and the beneficiary’s positions as time runs short. While the intention—to ensure the son always has a roof over his head—may be noble, Rogers stresses that the mechanics of such a transfer and the timing can trigger taxes, disputes, and unintended consequences that are hard to unwind later. She notes that there is a more straightforward route that can achieve similar aims with fewer complications: setting up a trust through the donor’s will.

Trusts can be set up during a person’s lifetime or through their will, and the type of trust chosen matters because different rules apply and the arrangement must fit the family’s circumstances. Trusts are managed by trustees, who can be family members or a professional such as a solicitor. Trustees bear responsibilities, especially where a vulnerable beneficiary may struggle to manage finances or may be susceptible to financial abuse. The aim is to tailor the arrangement to the beneficiary’s needs and to the resources available, while balancing tax and welfare considerations. Rogers outlines three common forms that might be considered in this case: an interest in possession trust, a discretionary trust, and a vulnerable person’s trust.

1. Interest in possession trusts. These give the life beneficiary—the intended user, in this case the nephew—the right to use an asset such as a house or to receive income from the trust during their lifetime, while the ultimate ownership remains with the trustees. A life tenant cannot sell the asset itself unless the trust deed provides for changes. Income generated by the trust may be paid to the life tenant, and this income could be subject to income tax. The life beneficiary’s right to income is relevant if means-tested benefits are involved. The assets within an interest in possession trust typically form part of the settlor’s estate for inheritance tax purposes, even if the beneficiary is living with the property. Capital gains tax can apply to disposals within the trust, though reliefs may exist for gains related to a main residence when conditions are met.

2. Discretionary trusts. In a discretionary trust, the trustees hold broad control over the assets and any income, and they decide when and how to provide for the beneficiaries. This structure offers flexibility to accommodate changing circumstances of a vulnerable beneficiary and to protect the trust from the beneficiary’s personal financial events, such as divorce or bankruptcy. Because beneficiaries do not have a direct entitlement to the trust fund, the trust assets may not automatically form part of their estate. Discretionary trusts can be advantageous for safeguarding means-tested benefits, but they come with tax charges and ongoing costs: there can be a 10-yearly charge on the trust, exit charges when assets are paid out, and income tax on any trust-generated income. A donor can also leave a letter of wishes to guide trustees about their intentions.

3. Vulnerable Person’s Trusts (VPTs). A VPT is designed for beneficiaries who meet the definition of a vulnerable individual—such as a child under 18 who has lost a parent, someone in receipt of certain disability benefits, or a person unable to manage their affairs due to a mental health condition. A VPT enables appropriate trustees to manage the trust funds, with potential favorable tax treatment when properly structured. Like discretionary trusts, a VPT typically does not form part of the beneficiary’s estate in the same way as direct ownership, which can help with eligibility for means-tested benefits. The tax treatment of income and gains can be aligned with the beneficiary’s own rates, though this arrangement must meet strict criteria to qualify as a VPT.

Property and structure: what is the best way to protect a son? Rogers emphasises that the most robust approach is often to create a trust through the brother’s will, rather than transferring the home during the donor’s lifetime. A qualified solicitor who specializes in trusts and protection can assess whether the nephew qualifies as a vulnerable beneficiary and advise on the most suitable form. The solicitor can also advise on practical matters, including whether home visits or remote consultations are appropriate given the brother’s health. It is also important to understand that the residence nil-rate band (the main residence tax relief) cannot be claimed against an estate if the home or its proceeds are left to a trust rather than directly to descendants.

What are the potential problems with the current plan? From the donor’s perspective, making a lifetime gift of the family home could raise deprivation of assets concerns under the Care Act 2014 if the donor’s needs later require state support. If the donor survives less than seven years after the transfer, the gift could remain within the donor’s estate for inheritance tax purposes. If the donor continues to live in the house after gifting it, that arrangement could be treated as a “gift with reservation of benefit” and remain subject to inheritance tax even if the donor survives beyond seven years.

From the recipient’s perspective, once the house is transferred or sold, the resulting proceeds may be treated as part of the donor’s estate for inheritance tax purposes. If the property is sold by the recipient, capital gains tax could apply on the gain, because the transaction would be considered between connected parties rather than a normal market sale. If the recipient later transfers the cash to a trust or transfers the property into a trust rather than selling, this could trigger a chargeable lifetime transfer (CLT). The CLT is subject to the seven-year rule, and the trust itself could face an inheritance tax charge on the value placed into the trust above £325,000, with a 20 percent rate on the excess, depending on the value involved.

Given these risks, Rogers recommends consulting a trust and protection specialist solicitor as soon as possible. She notes that the value of the brother’s estate and the value of the house will influence the analysis, and that tax reliefs, such as main residence relief, have particular conditions. The solicitor can determine which form of trust is most suitable for the family’s circumstances and can coordinate the process to ensure that the donor’s wishes are respected while minimizing unintended tax exposure. It may also be possible for a solicitor to arrange a home visit or remote meeting for a patient who is ill.

Readers considering similar arrangements should be aware that Heather Rogers’ responses are informational and not a substitute for regulated financial or legal advice. Readers are encouraged to consult professional advisers who can tailor guidance to their specific situation. For those seeking further assistance, government-backed MoneyHelper offers free guidance on financial matters, and readers may contact a qualified solicitor to discuss trust options and protections in depth.