Inheritance tax: a guide
What are the inheritance tax implications of inheriting – or bequeathing – a home?
Death and taxes, to paraphrase Benjamin Franklin, are the only certainties in life; and both come to the fore when a property is inherited.
Amid the grief of losing a loved one, taxes must still be paid, and whether the passing of a family member has brought you a property, or you are looking to bequeath one after your own death, there are rules around the tax you or your beneficiary may have to pay.
“Few people plan for death,” says chartered tax adviser Marc Emblem. “But if you do intend to gift property, or if you receive it yourself, you do need to be aware of the potential tax implications.”
So what are the rules, how much can you pass on tax-free – and how do you go about bequeathing property while you’re still living?
What is inheritance tax?
“Inheritance tax (IHT) is a levy on the estate of someone who has died,” says Emblem. “But it can also apply during your lifetime on certain gifts of property to trusts and companies.”
How much is payable?
Anything over the IHT threshold is generally liable to 40% inheritance tax. That threshold is currently £325,000 per person – and any unused threshold is transferable on death to a spouse or civil partner, bringing the survivor’s threshold to £650,000.
Furthermore, two years ago the government acted to reduce the tax burden further by introducing an additional threshold when a residence is passed on to a direct descendant – as long as the deceased lived in it at some time and it wasn’t a buy-to-let. The additional threshold currently stands at £125,000 but rises to £175,000 by 2021, meaning that a couple’s home would have to be worth £1m (twice the £325,000 IHT threshold plus two £175,000 nil-rate bands) before their descendants would have to pay any inheritance tax.
With such high thresholds, taxes might not be so inevitable after all for most beneficiaries of an inheritance – indeed, according to HMRC only 4% of British estates are liable at all. But, thanks to rising property prices and people living longer, that figure is increasing – in 2017/18 bereaved families paid the taxman a record IHT haul of £5.2bn, almost double the amount paid in 2009/10.
Bequests before you die
There are three times as many Britons over the age of 90 now than there were in the 1980s – which is pushing up the number of people who want to give away their wealth while they and their descendants are young enough to enjoy it.
According to HMRC, only 4% of British estates are liable for IHT. But, thanks to rising property prices and people living longer, that figure is increasing – in 2017/18 the taxman received a record haul of £5.2bn
You are entitled to gift your property to your children at any time – and, if you then live beyond seven more years, it is generally not subject to inheritance tax. However, if you continue to benefit from the property (e.g. by living in it without paying full market rent), the property will remain within charge to IHT.
If your children do charge you full market rent while you still live in it, they will be subject to income tax on the rental income, which could exceed any IHT saving over time when you factor in the various thresholds.
It’s a gift
There are, however, several other ways to gift part of your estate during your lifetime. “Each person has an IHT allowance of £3,000 a year they can gift,” says Emblem, and unused allowance rolls over to the following year. “You can also gift £1,000 for a wedding: £1,000 per person, although £5,000 for a child, and £2,500 for a grandchild or great grandchild. And you can make as many additional regular gifts as you like, known as ‘normal expenditure out of income’, as long as you can prove you are left with sufficient income to maintain your standard of living.”
Gifting to your children also risks being seen as ‘deliberate deprivation of assets’ (intentionally devaluing your estate to make yourself eligible for local authority care or housing), and family circumstances may also change: if your descendant got divorced, for example, would they have to sell the asset?
You can also mitigate your liabilities in other ways, adds Emblem: “Taking out life insurance could cover your inheritance tax and/or provide a lump sum on your death to your beneficiaries, which normally would fall outside your taxable estate.”
But, concludes Emblem, decisions should not be made based on tax savings, but on how you want to support your descendants. “Passing on your property, whether now or after you die, is not about mitigating or avoiding tax liabilities, but working out what is best for your family – why, how and when you want to pass on your property,” he says. “Any decisions should be made from a place of how you want to support your children.”