A bitesize guide to Inheritance Tax

 

There is usually no inheritance tax to pay if either the value of the estate is below the inheritance tax threshold, which is currently £325,000, or everything above the threshold of £325,000 is left to a spouse, civil partner or a charity. This is known as the ‘nil rate band’. 

 

If couples are married or in a civil partnership, and the first to die’s estate is worth less than the threshold, or is transferred to a spouse, civil partner or charity, any unused threshold can be added to their spouse’s or civil partner’s threshold when they die, i.e., on second death. 

 

 

The standard rate of inheritance tax is 40%, this is only charged on the part of an estate which is above the £325,000 threshold. 

 

For example: 

 

If an estate is worth £500,000 then it will be taxed at a rate of 40% on £175,000 (£500,000 less £325,000). 

 

Inheritance tax is reduced to a rate of 36% where 10% or more of the net chargeable value of the estate is left to a charity or charities. The net chargeable value is the total value of the estate minus any debts. 

 

 

Where a home is passed to a spouse or civil partner on first death, there is no inheritance tax to pay. However, if the home is left to another person, it will count towards the value of the estate. 

 

Where an individual owns their home (or a share in it) the tax-free threshold can be increased by up to £175,000, known as the residential nil rate band, if the home is left to their direct descendants (including adopted, foster or stepchildren), and the estate is worth less than £2 million. 

 

Therefore, an individual can leave up to £500,000 inheritance tax free. Any unused residential nil-rate band is transferred to a spouse or civil partner on their death and is available under the same terms. 

 

 

For estates worth more than £2 million, the residential nil rate band will gradually reduce or taper away, even if a home is left to direct descendants. 

The residential nil rate band reduces by £1 for every £2 that an estate is worth more than the £2 million taper threshold. 

 

For example: 

 

An individual passes away leaving an estate of £2,100,000 to his children, including a home worth £450,000. 

 

The maximum residential nil rate band is £175,000. 

 

As the estate is worth more than the taper threshold of £2 million by £100,000 and the residential nil rate band tapers away by £1 for every £2 that the estate is more than the taper threshold, the residential nil rate band in this case reduces by £50,000. Therefore, the maximum residential nil rate band that the individual can use is £125,000. 

 

Where an estate is worth £2,350,000 or more, the residential nil rate band of £175,000 completely tapers away. 

 

 

There is usually no inheritance tax to pay if an individual gifts their property, moves out and lives for 7 years after the transfer. 

 

If they wish to continue living in the property after giving it away, they will need to pay rent to the new owner at the going market rate, pay their share of the bills, and live there for at least 7 years. 

 

Otherwise, this counts as a gift with reservation and will be added to the value of their estate when they pass away. 

 

 

Inheritance tax may be payable after death on some gifts given. Gifts given less than 7 years before death may be taxed depending on who the gift is given to and their relationship to the individual, the value of the gift, and when the gift was given. 

 

Items that count as a gift can include: - 

 

• Money 

• Household and personal goods such as furniture, jewellery or antiques 

• House, land or buildings 

• Stocks and shares listed on the London Stock Exchange 

• Unlisted shares held for less than 2 years before death 

 

Gifts can also include a loss when something is sold for less than it is worth i.e., selling a house to a child for less than the market value. The difference in value counts as a gift. 

 

 

Annual Exemption – Each person can give away a total of £3,000 worth of gifts each tax year without them being added to the value of the estate. This may be gifted to one person or split between multiple people. 

 

Any unused annual exemption can be carried forward to the next tax year – but only for one tax year. 

 

Small gift allowance – Each person can give as many gifts of up to £250 per person as they wish each tax year, provided that they have not used another allowance on the same person. 

 

Birthday or Christmas gifts made from regular income are exempt from inheritance tax. 

 

Gifts for weddings or civil partnerships – Each tax year, tax-free gifts can be given to someone who is getting married or entering a civil partnership. The allowances are as follows: - 

 

• £5,000 to a child 

• £2,500 to a grandchild or great-grandchild 

• £1,000 to any other person. 

 

If gifts are given to the same person, a wedding gift allowance can be combined with any other allowance, except for the small gift allowance. 

 

 

No tax is due on any gifts if a person lives for 7 years after giving them. 

 

If a person dies within 7 years of giving a gift and there is inheritance tax to pay on it, the amount of tax due after their death depends on when they made the gift: - 

 

Years between gift and death Rate of tax payable on the gift 

3 to 4 years 32% 

4 to 5 years 24% 

5 to 6 years 16% 

6 to 7 years 8% 

7 years or more 0%