What is an interest in possession trust and how is it taxed?

Full answer

An interest in possession (IIP) trust is a type of trust where one beneficiary — the life tenant — has an immediate right to the income produced by the trust assets for their lifetime (or another specified period). When that interest ends (usually on death), the capital passes to the remaindermen. **Income tax** The life tenant is taxed on trust income as if they received it directly. The trust pays income tax at the basic rate (20% on most income, 7.5% on dividends), and the life tenant receives a tax credit for tax already paid, settling their own liability at their marginal rate. **Capital Gains Tax** When trust assets are sold, CGT is payable by the trustees at the standard rates (10%/20% for most assets; 18%/24% for residential property). The annual CGT exempt amount for trusts in 2026/27 is £1,500 (half the individual allowance of £3,000). **Inheritance Tax** This is the distinctive feature: the trust assets form part of the life tenant's taxable estate on death (known as an "estate IIP"). The life tenant is treated as owning the capital for IHT purposes, even though they cannot access it. IHT is charged at 40% on the trust fund above the life tenant's available nil-rate band. **Creation — when does IHT apply?** IIP trusts created on death (via a will) are exempt from immediate IHT if assets pass to a surviving spouse (spouse exemption). IIP trusts created during lifetime after 22 March 2006 are treated as relevant property trusts (subject to 10-year anniversary charges and exit charges). **Uses** Common uses include providing income for a surviving spouse while preserving capital for children from a previous marriage (life interest will trust).

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