What is the best way to give an adult child an early inheritance?

An early inheritance can give your child a significant advantage, but it is more complicated than simply handing them a huge sum of money or putting an asset into their name.

Before choosing the structure for the early inheritance, it is important to understand the different alternatives and the tax implications.

Donating money or assets to your child

You can give your child a gift in the form of an asset or money, but there may be tax implications. SARS considers this a donation, and you must pay donations tax if the value exceeds R100 000. Read more: What is donations tax?

This applies to all donations you make per tax year, so if you give money or an asset to more than one person per tax year, these amounts are combined, and only the first R100 000 is exempt.

The R100 000 exemption is per individual, so you and your spouse can transfer R200 000 per year to your child.

Loan agreement

If you want to give your child a large amount of money, you can structure this as a loan agreement between you and your child. This avoids donations tax because the loan is an asset in your estate and subject to estate duty. You can specify the repayment terms and interest rate in the loan agreement, and you can state in your will that the loan does not need to be paid back.

You can also reduce this loan each year by R100 000 without incurring donations tax. As an example, a loan of R500 000 can be nullified in five years, tax free, and the R500 000 is no longer an asset in your estate.

Giving your child property

If you wish to give your child a property, you can donate it, sell it, or place it in a trust. In all instances, transfer costs need to be paid as well as transfer duty if the property value exceeds R1.1 million. SARS requires three market valuations to determine a reasonable value for the property.

If you donate the property to your child, you will be liable for donations tax on the market value of the property that exceeds R100 000.

If you sell the property to your child at a price that is significantly below market value, SARS will view the difference as a donation, and you will be liable for donations tax on the amount exceeding R100 000.

You may also be liable for capital gains tax.

A conveyancing attorney will facilitate the transfer process, starting with a Deed of Sale or a Deed of Donation, whichever applies.

Establishing a trust

You can also give your child the benefits of your property and other assets by establishing an inter vivos trust. This is a living trust that allows you to transfer assets that are designated for your children or grandchildren. There are two types of trusts: discretionary trusts in which the trustees decide on how much of the income or capital gain is paid to the trust beneficiaries, and vesting trusts, in which the income and capital gain is automatically paid to the trust beneficiaries.

A trust might be useful for leaving a property to a child or grandchild. You can specify a termination date in the trust deed, after which the trust is dissolved and all assets distributed to the trust beneficiaries.

When you place an asset in a trust, you either donate or sell it to the trust and you relinquish all control over the asset. The asset is controlled by the trust through its trustees. If you sell the asset you would typically do so via a loan and the loan would be considered an asset in your estate.

The loan’s value is pegged at the date you sell the asset to the trust. All growth of the asset after that date happens within the trust, so when you die, the value in your estate remains at the value of the loan for the purposes of estate duty.

You need to carefully evaluate all the implications before establishing a trust and transferring your assets to it, including the loss of control and the ongoing costs of administering the trust. Consult a tax or legal professional before making a final decision.

Weighing up the options

There are pros and cons to an early inheritance. It reduces the value of your estate, resulting in lower estate duty, however, it can create an immediate donations tax problem.

Depending on the size of your estate and personal preference, you may choose not to give an early inheritance and pay donations tax but rather let the asset increase in value and make your estate liable for estate duty when you die.  The first R3.5m of your estate is exempt from estate duty.

There is also a more generous capital gains exclusion for estates: the first R300 000 of taxable capital gains are excluded from CGT, as opposed to the first R40 000 each year while you are alive. There is also no transfer duty payable for properties inherited as part of an estate.

On the downside, other transfer costs on properties are linked to the property’s value; therefore leaving it to be inherited in the future may result in higher transfer costs than if it is given as early inheritance.