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Inheritance Tax (IHT) Planning

Gifting & Property: How to Reduce your IHT Bill

Transferring property and assets during your lifetime can help reduce your IHT bill but the rules are complex. From the seven-year rule to downsizing relief and main residence considerations, we cover what you need to know.
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Inheritance Tax Planning | Estate Planning | Trusts | Wills

The Seven-Year Rule for Gifts is an important aspect of Inheritance Tax (IHT) legislation.

Under U.K. tax law, gifts made during a person's lifetime can be subject to Inheritance Tax (IHT) if the donor dies within seven years of making the gift. The seven-year rule helps determine whether these gifts are liable for Inheritance Tax (IHT) and how the tax is calculated.

Gifts made more than seven years before death are generally exempt from IHT.

If you give a gift and live for seven years after making that gift, it generally falls outside of your estate for IHT purposes.

If you die within seven years of making the gift, it may be included in your estate, potentially subjecting it to IHT.

Taper Relief:

If you die within the seven years, the amount of IHT due on the gift may be reduced by what is known as "taper relief".

Taper relief applies if the gift was made between three and seven years before death. The relief reduces the IHT due on the gift based on how many years have passed since the gift was made:
3 to 4 years: 20% reduction
4 to 5 years: 40% reduction
5 to 6 years: 60% reduction
6 to 7 years: 80% reduction
No relief applies if the gift was made less than three years before death.

Annual Exemption:

Each individual can gift up to £3,000 each tax year without it counting towards their estate when calculating Inheritance Tax (IHT). This is known as the "annual exemption".

If the full exemption is not used in one year, it can be carried forward to the next year, but only for one year.

Other Exemptions:

Certain gifts are exempt from IHT regardless of the seven-year rule, such as gifts to spouses or civil partners, charitable donations, and small gifts up to £250 per person each tax year.

Potentially Exempt Transfers (PETs):

Gifts made during a person's lifetime are categorised as Potentially Exempt Transfers. If the donor survives for seven years after making the gift, it becomes exempt from IHT. If they do not survive, the gift may be taxed.

The Seven-Year Rule for Gifts (IHT): Example Scenario

Gift Amount: A parent gives their child £50,000 in 2020. 
Parent's Death: The parent passes away in 2023. 
IHT Implications: Since the gift was made three years before death, it is a potentially exempt transfer. However, it is subject to taper relief, reducing the IHT liability on that gift. 
The seven-year rule for gifts is a crucial consideration for estate planning. By understanding this rule and the associated exemptions, individuals can make informed decisions about gifting during their lifetime and effectively manage their Inheritance Tax liabilities.

Understanding and planning for Inheritance Tax (IHT) is crucial for protecting your family's financial future. By taking proactive steps, you can ensure that more of your estate is passed on to your loved ones rather than going to the taxman. 

We offer complimentary consultations with a local financial adviser, including a free review of your assets and estate, along with our expert recommendations. There’s no obligation - fees only apply if you choose to proceed with our advice.
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Gifting a Property & Inheritance Tax (IHT) Planning

When a gift is a property, the seven-year rule for Inheritance Tax (IHT) operates similarly to other types of gifts but with some specific considerations. Here’s a detailed overview of what happens when you gift a property:

Potentially Exempt Transfers (PETs)

When you gift a property, it is classified as a Potentially Exempt Transfer (PET). If you survive for seven years after making the gift, the property will not be included in your estate for IHT purposes.

If you pass away within seven years, the property may be subject to IHT.

Valuation of the Property

When gifting property, it must be valued at the time of the gift. The value of the property will be used to determine whether it exceeds the nil rate band (currently £325,000) and whether IHT applies.

Taper Relief

If you die within seven years of making the gift, taper relief may apply. The amount of IHT due on the property will be reduced based on how many years have passed since the gift was made:
3 to 4 years: 20% reduction
4 to 5 years: 40% reduction
5 to 6 years: 60% reduction
6 to 7 years: 80% reduction

Gift with Reservation of Benefit

If you gift a property but continue to live in it without paying a market rent, the gift may be considered a "gift with reservation of benefit." In this case, the property remains part of your estate for IHT calculations, as you are still benefiting from it.

Main Residence Nil Rate Band

If the property is your main residence and you pass it to direct descendants (children or grandchildren), the Main Residence Nil Rate Band (RNRB) may apply, potentially increasing the threshold for IHT.

Capital Gains Tax (CGT)

Gifting property can also trigger Capital Gains Tax (CGT) liabilities. If the property has increased in value since you acquired it, you may need to pay CGT based on the gain realised at the time of the gift. However, your main residence may be exempt from CGT under certain circumstances.

Gifting a Property (IHT): Example Scenario

Gift: A parent gifts their home valued at £500,000 to their child in 2021. 
Parent's Death: The parent passes away in 2023. 
IHT Calculation: Since the gift was made two years before death, the property is subject to IHT. The value of the property (£500,000) will be considered when calculating the estate's total value. If the total estate exceeds the nil rate band, the excess will be taxed at 40%.
Taper Relief: If the parent had survived for more than three years, taper relief could reduce the tax liability.
Gifting property involves several considerations regarding Inheritance Tax, including the seven-year rule, valuation, taper relief, and potential tax implications. Proper planning is essential to minimise tax liabilities and ensure that gifts are passed on effectively.

Impact of Selling a Property on RNRB Eligibility

If a property that qualifies for the Main Residence Nil Rate Band (RNRB) is sold before the owner's death, several factors come into play regarding the eligibility for the RNRB. Here’s how it works:

1. RNRB Requirements

To qualify for the RNRB, the property must be the individual’s main residence at the time of death and must be passed on to direct descendants (such as children or grandchildren). 

If the property is sold before death, the following considerations apply:

2. Replacement Property

If the individual sells their main residence but then buys another property, the RNRB can still apply to the new property if it becomes the main residence.

The key factor is that the new property must be the main residence at the time of death and meet the conditions for passing it on to direct descendants.

3. No Property Ownership at Death

If the individual sells their main residence and does not own any property at the time of death, they will not qualify for the RNRB. The allowance is specifically tied to the ownership of a main residence at the time of death.

4. Gift of Property

If the individual gifts the property to direct descendants before death and subsequently sells it, the RNRB would apply to the value of the property at the time of the gift, assuming the donor survives for seven years after the gift.

5. Downsizing Relief

If an individual sells a property that qualifies for the RNRB and then downsizes to a less expensive property, they may still be able to claim the RNRB on the value of the original property, provided it was passed to direct descendants.

This relief allows for some flexibility in estate planning, as it acknowledges that individuals may change their living circumstances.

Selling a Property on RNRB: Example Scenario

Original Property: An individual owns a home valued at £600,000 and plans to pass it to their children. They sell the property in 2022. 
New Property: The individual purchases a smaller home valued at £300,000 and lives there until they pass away in 2024. 
IHT Implications: If the new property is the main residence at the time of death and is passed on to direct descendants, the RNRB could still apply, potentially allowing for a tax-free threshold.
Selling a property that qualifies for the Main Residence Nil Rate Band before death can affect eligibility for the RNRB. However, as long as the individual has a new main residence at the time of death, or if they have downsized, they may still benefit from the RNRB. Proper planning and understanding of these rules can help maximize the tax advantages for heirs.

Downsizing Relief Overview

Downsizing relief in the context of the Main Residence Nil Rate Band (RNRB) is designed to support individuals who sell their main residence and move to a less expensive property, ensuring they can still benefit from the RNRB. Here are the specific rules and details regarding downsizing relief:

1. Eligibility Criteria

To qualify for downsizing relief, the following conditions must be met:
Sale of Main Residence: The individual must have sold or gifted a property that was their main residence.
Acquisition of a New Property: The individual must have moved to a less valuable property or have moved into a care home.
Time Frame: The sale of the original property and the subsequent move must occur at any time prior to death, but the downsizing relief applies specifically when claiming the RNRB.

2. Value Considerations

The downsizing relief allows the individual to claim the RNRB based on the value of the original property, even if the new property is of lower value.

The relief effectively allows for the RNRB to be calculated as if the individual still owned the original property.

3. Transferring the RNRB

If the property sold was worth more than the new property, the RNRB can be claimed based on the value of the original main residence up to the maximum limit. The RNRB applies as long as the property is passed on to direct descendants (children or grandchildren).

4. Main Residence Nil Rate Band Limitations

The downsizing relief does not increase the overall RNRB limit; it merely allows individuals who have downsized to still qualify for the RNRB up to the original property's value.

The RNRB limit is £175,000 (as of 2023) per individual and is subject to tapering for estates valued above £2 million.

5. Claiming the Relief

When filing the estate for IHT purposes, it is essential to declare the downsizing relief and provide details of the properties involved.

It is advisable to keep documentation of the sale of the original property and the purchase of the new property for accurate reporting.

Downsizing Relief (IHT): Example Scenario

Original Property: An individual sells their home for £600,000. 
New Property: They purchase a new, smaller home for £300,000. 
Death: The individual passes away and leaves the new property to their children.
RNRB Application: Although the new property is worth less, the individual can still claim the RNRB based on the original property’s value (£600,000), provided it meets the criteria for passing it to direct descendants.
Downsizing relief is a valuable provision that allows individuals who sell their main residence and move to a less expensive property to still benefit from the Main Residence Nil Rate Band. Understanding the eligibility criteria and how to claim this relief can significantly impact Inheritance Tax planning.

Implications of Gifting a Property That Is Not the Main Residence at Death

If a gifted property is not the main residence at the time of death, it has specific implications for Inheritance Tax (IHT) and the Main Residence Nil Rate Band (RNRB). Here’s how this situation is handled:

1. RNRB Eligibility

The Main Residence Nil Rate Band (RNRB) applies specifically to a property that was the individual's main residence at the time of death. If the gifted property is not the main residence at death, the RNRB cannot be claimed for that property.

2. Potentially Exempt Transfers (PETs)

Since the property was gifted, it is treated as a Potentially Exempt Transfer (PET). If the donor dies within seven years of making the gift, the value of the property may be included in the estate for IHT calculations.

If the donor survives for more than seven years, the property is generally excluded from their estate.

3. IHT Calculation

If the gifted property is not the main residence at the time of death and the donor dies within seven years of gifting:              
The value of the gifted property will be included in the estate for IHT calculation.
The standard nil rate band (£325,000) will apply to the total estate value, and any amount above this threshold will be taxed at the standard rate of 40%.

4. No RNRB Application

Without the RNRB applying, the estate may face a higher IHT liability, especially if the total estate value exceeds the nil rate band.             

Gifting a Property That Is Not the Main Residence at Death: Example Scenario

Original Gift: An individual gifts a property worth £400,000 to their child. 
New Main Residence: The individual then moves to a different property, which becomes their main residence. 
Death: The individual passes away three years later.
RNRB Application: Although the new property is worth less, the individual can still claim the RNRB based on the original property’s value (£600,000), provided it meets the criteria for passing it to direct descendants.
IHT Implications: The gifted property is not considered the main residence at the time of death, so the RNRB cannot be claimed for it. As the individual died within seven years of the gift, the value of the gifted property (£400,000) will be included in the estate for IHT calculations. The total estate value will determine whether any IHT is due.
If a gifted property is not the main residence at the time of death, it does not qualify for the Main Residence Nil Rate Band. The property may still be subject to Inheritance Tax if the donor dies within seven years of the gift.

Implications of Gifts Made More Than 7 Years Ago

If a gifted property is not the main residence at the time of death, it has specific implications for Inheritance Tax (IHT) and the Main Residence Nil Rate Band (RNRB). Here’s how this situation is handled:

1. Potentially Exempt Transfers (PETs)

Exclusion from Estate: Gifts made more than seven years before the donor's death are considered Potentially Exempt Transfers (PETs) and are excluded from the donor's estate for IHT purposes.

No IHT Liability: This means that the value of the gifted property will not be included in the estate when calculating IHT, regardless of whether the property was the main residence at the time of death.

2. No RNRB Application

Since the property is not part of the estate, the Main Residence Nil Rate Band (RNRB) will not apply to the gifted property. The RNRB is only relevant for properties that are included in the estate at death.

3. Impact on IHT Calculation

If the total value of the estate (excluding the gifted property) exceeds the nil rate band (currently £325,000), any amount above this threshold will be subject to IHT at the standard rate of 40%.

For example, if the estate is valued at £600,000 and includes no properties that are subject to PET rules, the calculation would be:              
Total Estate: £600,000
Nil Rate Band: £325,000
Taxable Amount: £275,000
IHT Due: 40% of £275,000 = £110,000

4. Previous Gifts Still Considered

While gifts made more than seven years ago are excluded, any gifts made within the last seven years will still be considered for IHT calculations if the donor dies within that timeframe.

This means that if the donor made multiple gifts over the years, only the most recent ones (within seven years) would be relevant for IHT purposes.            

Gifts Made More Than 7 Years Ago: Example Scenario

Gift: An individual gifts a property worth £400,000 to their child in 2010. 
Death: The individual passes away in 2024. 
Death: The individual passes away three years later.
IHT Implications:
- The gift made in 2010 is excluded from the estate since it was made more than seven years ago.

   - The estate is valued at £600,000 at the time of death, but the IHT calculation will be based only on the estate's current value.

   - If there are no other gifts made within the last seven years, the estate will be taxed solely based on its value above the nil rate band.
Gifts made more than seven years ago are effectively excluded from the estate for Inheritance Tax calculations, simplifying the IHT process for the remaining estate. Understanding the implications of these time frames is crucial for effective estate planning and tax management.

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Inheritance Tax Planning, Trusts, Tax Planning, Estate Planning, Will Writing & Powers of Attorney are not regulated by the Financial Conduct Authority.

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