Reversionary Interest Trusts: How the Tax Treatment Works
A reversionary interest — the right to receive trust capital or income at a future point, such as when a life tenant dies — has its own distinct Inheritance Tax and Capital Gains Tax treatment, separate from the underlying trust assets themselves.
What a Reversionary Interest Actually Is
In trust law, different beneficiaries can hold different types of interest in the same trust simultaneously. A common structure:
- A life tenant holds an "interest in possession" — the right to receive trust income (or use trust property, such as living in a trust-owned house) during their lifetime.
- A remainderman holds a reversionary interest — the right to receive the trust capital once the life tenant's interest ends, typically on the life tenant's death.
The remainderman doesn't currently benefit from the trust — they have no right to income or capital in the present — but holds a genuine, legally recognised future entitlement that itself has value and its own tax characteristics, entirely separate from the underlying trust assets it relates to.
Inheritance Tax: The "Excluded Property" Position
The key IHT concept for reversionary interests is whether the interest counts as excluded property:
| Type of reversionary interest | IHT treatment |
|---|---|
| Interest arising under the original trust settlement (not purchased) | Generally excluded property — falls outside the holder's own estate |
| Interest purchased for money or money's worth (e.g. bought from another beneficiary) | Generally loses excluded property status — can form part of the holder's estate |
| Interest where the settlor themselves is the person entitled to it | Specific anti-avoidance rules can apply, denying excluded property treatment |
Because most reversionary interests arise naturally under a family trust settlement (a parent setting up a trust with their child as remainderman, for example) rather than being bought and sold, the majority of reversionary interests in practice do qualify as excluded property — meaning the value of that future entitlement doesn't count towards the holder's own estate for Inheritance Tax purposes if they die before becoming entitled to the trust capital.
This Doesn't Mean the Trust Itself Is IHT-Free
It's important not to conflate the reversionary interest holder's personal IHT position with the separate IHT treatment of the trust itself. Depending on when and how the trust was set up:
- Trusts created since the 2006 IHT reforms are generally taxed under the "relevant property" regime, with periodic 10-yearly charges and exit charges on the trust's own value, regardless of the reversionary interest holder's excluded property status.
- Older trusts with a qualifying interest in possession (broadly, life interest trusts set up before the 2006 changes, or certain other qualifying categories) may instead be taxed as if the life tenant owned the underlying trust capital outright, with IHT potentially due on the life tenant's death based on the trust's value at that point.
The reversionary interest holder's own excluded property status doesn't shield the trust itself from whichever of these regimes applies to it — these are genuinely separate layers of the overall IHT analysis.
Capital Gains Tax on Reversionary Interests
Reversionary interests can themselves be bought, sold, or occasionally used as security, and these transactions can trigger CGT considerations:
| Event | CGT relevance |
|---|---|
| Reversionary interest arising under a settlement (not purchased) | No CGT event at the point of arising |
| Selling a reversionary interest for money | Potentially a chargeable disposal, CGT calculated on proceeds vs acquisition cost (often nil, if the interest arose under the settlement) |
| Reversionary interest becoming an outright entitlement (e.g. life tenant dies, remainderman becomes absolutely entitled) | Complex — potential CGT implications for the trust itself at this point, following specific trust CGT rules, separate from the beneficiary's own position |
Once sold for consideration, a reversionary interest also typically loses its excluded property status for IHT purposes going forward, since the exclusion generally depends specifically on the interest not having been acquired for money or money's worth — creating a compounding effect where selling the interest changes both its CGT and its future IHT treatment simultaneously.
Discounted Gift Trusts: A Related, More Commonly Used Structure
A more widely used form of estate planning building on similar principles is the discounted gift trust, where a settlor gifts a sum into trust but retains the right to fixed regular payments (effectively a reversionary-style retained income right) for their own lifetime or a fixed term, with the remaining capital passing to named beneficiaries. The value transferred for IHT purposes is "discounted" to reflect the value of the retained income right, potentially reducing the immediate IHT-relevant gift compared to the full sum invested. These structures use similar underlying concepts to reversionary interests but are packaged as an established, commercially available estate planning product, typically offered through insurance-based investment bonds.
Why Specialist Advice Is Essential
Reversionary interest trusts and related structures sit at the more technical end of UK trust and estate planning — involving the interaction of trust law, IHT excluded property rules, CGT trust provisions, and often significant sums of money. Anyone considering this kind of planning, whether setting up a new structure or dealing with an existing reversionary interest (as a holder, or in administering an estate that includes one), should get specialist advice from a solicitor or tax adviser experienced specifically in trust taxation, given how easily the excluded property and CGT positions can be inadvertently changed by seemingly straightforward transactions.
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