My grandparents kindly offered to pay off a six-figure amount on our mortgage.

We have to remortgage in the coming months and while I am blown away by their potential act of extreme financial kindness, I fear we will have a tax bite later.

Basically my grandfather is a successful business owner and still receives a regular salary. He still gets involved from time to time despite being in the mid-90s.

If he made this nice gift from a salary he gets paid at work, does that make a difference?

I politely declined the money stating the tax implications, but he insisted, saying the money is sitting in a checking account doing nothing. What would happen if I accepted cash? By email

Helen Crane of This is Money, responds: It’s a tricky situation to deal with – both financially and emotionally.

On the one hand, your grandfather made an extremely generous offer. This would greatly reduce the financial burden on your mortgage, and you don’t want to hurt his feelings by denying him.

But you also want to protect yourself against a hefty tax bill a few years down the road.

I asked Pervaze Ahmed, Head of Residential Real Estate, and Liz Palmer, Head of Private Management at Howard Kennedy Law Firm, to explain the rules on inheritance tax for donations during the lifetime of a grandparent.

They say: It is often mistakenly believed that if you receive money from someone, even if it is a family member, there is an immediate obligation to pay taxes.

This is not the case here, provided that your grandfather gives you this gift with taxed funds – which you suggest he is, because he receives a salary and pays taxes on that salary.

When you receive the gift, you don’t have to report it to anyone and you can use it to pay off your mortgage.

However, while you don’t have immediate concerns, you’ve rightly identified that there could be inheritance tax issues down the road.

Money received from a grandparent as part of an inheritance upon death is typically taxed 40% on anything over £ 325,000.

To prevent people from giving away their money shortly before death in an effort to avoid this tax, HMRC implemented a system called “potentially exempt transfers” – also known as the seven-year rule.

This means that cash donations are only exempt from tax if the donor survives for seven years after the donation. Otherwise, it will be subject to inheritance tax as if it were still part of the donor’s estate, on a degressive basis. This applies regardless of whether the funds come from a salary.

In the best-case scenario, your grandfather will survive another seven years, which, while unlikely, is possible.

If he does, then the money he gave you will be outside his estate for inheritance tax purposes.

However, if your grandfather doesn’t survive for the next seven years, you’ll have to pay inheritance tax on the gift – if your grandfather has already used the £ 325,000 in his zero-rate tax bracket.

You get a discount based on the time elapsed since the gift was given, as below.

Here is an example of how it might work:

Peter donated £ 350,000 to his son James on July 1, 2015. He passed away on November 5, 2018.

The donation was made more than three years before Peter’s death and was worth above the zero rate range available (£ 325,000) on the date of his death. As a result, inheritance tax was due on £ 25,000 of the donation.

If the gift had been given as a simple inheritance, James would have had to pay 40% of £ 25,000, or £ 10,000.

But since the donation was made between three and four years before Peter’s death, a graduated 20% abatement applied to the tax payable.

This meant that James was paying £ 2,000 less, so his inheritance tax bill was £ 8,000.

If your grandfather’s estate was less than £ 325,000 donated to you, it would still be under the zero rate bracket and you would not have to pay anything.

While the donation can help pay off the mortgage faster, it could lead to a tax headache.

Potential exemption for multiple and regular donations

There is a potential exemption to all of this – but it would require your grandpa to donate more money.

If your grandfather is able to make this donation entirely from his salary, and he plans to do so on a regular basis – for example by donating to other grandchildren – he may qualify for duty waiver. inheritance which is called ‘normal expenditure on income’.

When donations are made regularly from taxed income that is clearly in excess of the donor’s needs and does not spend its capital instead, the donor does not need to survive that seven-year period – he immediately leaves his estate.

There is no set limit on how much to give, and it doesn’t have to be the exact same amount every time.

The important thing is that HMRC is convinced that the income is in excess of the donor’s needs.

If you had an income of £ 100,000 each year and your living expenses were £ 50,000, for example, you could donate the extra £ 50,000 as long as you don’t spend your capital on living.

Once a year should be fairly regular, and if your grandfather ends up with this donation pattern, then he would not have to survive seven years for the donation to be deducted from inheritance tax.

Regular donations over a period of several years could benefit from an exemption from inheritance tax

Helen Crane, This is Money, responds: Unfortunately for you, a grandparent’s donation is still subject to some degree of inheritance tax for seven years – even if it comes from a salary.

He’s been very generous in the past – but if your grandpa was considering giving some extra gifts, it might work to your advantage.

There is no set timeframe for establishing a donation model, although evidence suggests that three to four years would normally be reasonable.

However, there have been cases, albeit rare, where a single donation was made near death, but HMRC granted the exemption because it decided it was destined to be the first of a series of payments.

Unfortunately, there is no way to know for sure whether HMRC would accept your grandfather’s donation as a valid exemption until his death.

Therefore, you will need to weigh the beneficial effect this gift would have on your finances in the short term against your ability to pay the inheritance tax – or a portion of it – later if you needed to.