I want to leave my house to my children – will they need to pay Inheritance Tax?.

With property prices continuing to increase and growing wealth in the older population, more estates could be liable to pay Inheritance Tax.

So, what are the rules around who needs to pay, how much can you leave to a loved one tax-free, and what can be done to make sure your family receives as much of their inheritance as possible?

In this helpful guide, we share some of the important things you need to know about Inheritance Tax. For more information, you should consult a solicitor specialising in inheritance and the government’s website for the latest updates.

What is Inheritance Tax (IHT)?

Inheritance Tax (IHT) is a 40% tax on the value of someone’s estate – possessions, property, savings – over a tax-free threshold. It doesn’t apply if the estate is left to a spouse, civil partner, or charity in its entirety.

The value of any property or money that was gifted (above a tax-free annual amount) during the seven years before death will also be added to the value of the estate. However, the amount of tax on these gifts will vary based on how long ago it was received.

If a person has outstanding debts when they die, the value of these debts is deducted from the total value of the estate for Inheritance Tax purposes. However, these debts will need to be settled by the executor of the will.

What is the Inheritance Tax threshold?

The standard Inheritance Tax threshold (or Nil Rate Band) is £325,000. This means that a person can leave assets up to this amount to anyone after they die without it being liable to tax. So, if an estate is worth £375,000, the tax would only apply to the £50,000 above the threshold.

If the person leaves their home – their personal main residence – to a child (including adopted, foster and step children) or a grandchild, the threshold rises to £500,000 (on estate’s valued up to £2 million). The recipient needs to be a linear descendent, so this extra allowance doesn’t apply if the property is left to a sibling or sibling-in-law, niece or nephew, or a friend.

An executor can also request that HMRC transfer any unused tax allowance from the person’s deceased partner, as long as they were married or in a civil partnership at the time of the first death, and the request is sent to HMRC within 2 years of the surviving partner’s death.

By adding both partner’s standard inheritance tax threshold and Residence Nil Rate Band allowance, it is possible to get a tax-free allowance on up to £1 million on an estate’s value.

There are specific criteria and exemptions which you’ll be able to find on the government’s advice pages, but you should always check with a legal representative before making any decisions involving inheritance planning.

What happens if I gift my property to my children before I die?

Transferring ownership of a property to children, grandchildren or other family member can be a good way of minimising larger estate values and inheritance tax.

However, it’s not quite as straightforward as it sounds and there are some caveats.

The gift is only exempt from Inheritance Tax if:

The person gifting the property survives for seven years after the date of transfer,

• If they pass away within three years, the 40% rate tax will apply.
• If they pass away after three years but before seven years from the date of transfer, the rate will reduce for every year that has passed.

The person either no longer lives in the property, lives with the beneficiary, or pays market rent to the beneficiary (which they’ll need to pay income tax on).

• If the person continues to live in the house rent free, HMRC will class it as a ‘Gift with Reservation of Benefit’, and it will be included in the value of the estate.

What happens with Inheritance Tax if I downsize and want to gift equity to my children?

For many retired individuals and couples, the prospect of downsizing can be an attractive choice, especially after their children leave the nest and they don’t need the extra space anymore.

Downsizing can also unlock equity as the smaller property will often be less expensive than the larger property. Some downsizers take this opportunity to fund their new lifestyle, make quality of life home improvements, or gift the inheritance that their loved ones would receive early.

As it’s a gift, the same seven year rule described above applies. If the person giving the gift lives for at least another seven years, the amount gifted is exempt from inheritance tax.

What happens if I want to leave money to charity as well?

Firstly, if you want to leave any money to charity, no Inheritance Tax will need to be paid on that amount, and it will be deducted from the overall value of the estate.

Leaving more than 10% of an estate to charity may mean that the Inheritance Tax rate reduces from 40% to 36% on the rest of the taxable estate. You should speak to a solicitor or gain independent legal advice as special rules can apply.

Inheritance planning can help give you the peace of mind that your family and friends will be taken care of after you’ve gone, so it’s important to get independent legal advice before making any major decisions.

Property often accounts for a large percentage of people’s estates, and, at Together, we can support you if you need the funds to achieve your long-term and short-term property ambitions.