Tax pitfalls loom in plan to fund vulnerable nephew’s housing via trust, expert warns

A terminally ill man’s plan to transfer his house to a relative to fund a trust for his adult son faces several tax and legal pitfalls, according to Heather Rogers, a UK tax columnist. Rogers outlines that while trusts can be effective tools for protecting assets and providing for vulnerable beneficiaries, the structure and timing of transfers are critical. The most straightforward approach, she notes, is to set up a trust through the deceased’s will, rather than making lifetime transfers that can complicate taxes and care-cost considerations.

Rogers explains that trusts come in several forms, each with different rules and implications. An interest in possession trust gives a life beneficiary—often the person who will ultimately benefit from the assets during their lifetime—the right to use the asset or its income, but not to sell the asset itself. The ultimate beneficiary is a third party, and income arising from the trust could be taxable if paid to the life tenant. The existence of income rights can also affect means-tested benefits and means the assets may still form part of the donor’s estate for inheritance tax purposes.

Discretionary trusts grant trustees broad control over both assets and income, with discretionary distributions to beneficiaries. These arrangements can provide flexibility to accommodate changing circumstances for a vulnerable beneficiary, such as a son who struggles with managing finances. Because beneficiaries do not have an automatic entitlement to the trust fund, the assets may not automatically form part of the beneficiary’s estate in events such as divorce, bankruptcy or death. However, depending on the amount placed into the trust, there can be significant lifetime and ongoing charges, and the trust itself may face capital gains tax when assets are disposed of. Income tax is typically payable on income generated within the trust by the trustees.

Vulnerable Person’s Trusts (VPTs) are designed for beneficiaries who meet specific criteria, such as being under 18, receiving certain disability benefits, or having a mental-health condition that impairs capacity. When properly structured, VPTs may enjoy favorable tax treatment and often avoid certain means-testing impacts. Like discretionary trusts, a VPT can keep the beneficiary’s interests from being considered in routine benefit assessments, though the trust itself will still incur tax charges at the trust level, with capital gains and income tax generally applying at the beneficiary’s rates when realized.

The key takeaway Rogers provides is that the donor’s plan to gift the home outright to the other person and then sell or reallocate proceeds into a trust carries several risks. If the donor later requires long-term care and their capital is depleted, a lifetime gift could be challenged as deprivation of assets under the Care Act 2014. Local authorities can investigate transfers that appear designed to lessen the donor’s expected care costs, and they may attach a charge to the property even if the gift did not immediately affect the donor’s ability to pay for care. If the donor dies within seven years of such a gift, the transfer can still be treated as part of the estate for inheritance tax purposes, defeating the objective of shielding assets.

From the recipient’s perspective, converting a lifetime gift into a sale or transferring assets into a trust can trigger capital gains tax. Related-party rules require transfers to be at market value, and any gain realized by the recipient can become a taxable event. If the chosen route is to place cash from the sale into a trust, this may also trigger a Chargeable Lifetime Transfer (CLT) and potentially a 20% inheritance tax charge on the value of the gift above an exempt threshold, unless a suitable exemption or relief applies. The seven-year clock governs many of these considerations; gifts made more than seven years before the donor’s death can fall outside the donor’s estate for inheritance tax, but shorter windows can produce substantial tax consequences.

Rogers emphasizes that the most prudent path is to work with a solicitor who specializes in trusts and protection to tailor the arrangement to the specific facts of the brother’s situation. A professional can review the nephew’s eligibility for a vulnerable beneficiary designation, determine whether a VPT or a discretionary trust offers the best balance of protection and tax efficiency, and confirm whether the main residence nil-rate band could be leveraged or would be lost depending on how the property is transferred. A solicitor can also advise on whether the home should be retained in the brother’s name and placed into a trust through his will, or whether other vehicles—such as a lifetime trust funded at death—might be more appropriate.

The guidance Rogers provides also covers practical considerations: the trust’s trustees should be carefully chosen, with one or more professionals (such as a solicitor) involved to ensure proper administration and compliance with governing rules. Trustees have duties to protect the vulnerable beneficiary and to manage funds in accordance with the trust deed. A letter of wishes from the donor can help guide trustees about the donor’s intentions for distributions and the long-term goals of the trust. In addition, the donor should consider how the property and any resulting cash flows will interact with the beneficiary’s disability benefits, pensions, and other income sources to avoid inadvertently reducing those benefits.

For families facing these decisions, Rogers urges proactive planning and transparent discussions among relatives, the beneficiary, and qualified advisers. The goal is to protect the vulnerable beneficiary while minimizing unintended tax charges and preserving options for future care requirements. The practitioner’s role is to translate the family’s goals into a structure that complies with current tax and trust law, reflects the donor’s wishes, and remains adaptable to changing circumstances—including the health and financial needs of the beneficiary and the donor’s own health trajectory.

If you would like to pose a tax question to Heather Rogers, the columnist behind this analysis, you can email taxquestions@thisismoney.co.uk. Rogers notes that answers are not a substitute for regulated financial advice, and readers should seek professional guidance appropriate to their circumstances. Government-backed resources and MoneyHelper remain accessible options for individuals seeking free help with financial matters, especially if they are elderly or on a low income. The guidance provided here synthesizes Rogers’ analysis of trust structures and the potential fiscal impacts for donors and beneficiaries alike, with the aim of informing families exploring this sensitive area of estate planning.